RIMM - When it pays to be wrong

I guess it pays some guys to be wrong. And it pays the rest of us to take the opposing view of someone who has proven themselves to be wrong. On Dec 10, Morgan Keegan analyst Tavis McCourt published his views on RIMM, and told everyone that he thought there would be a “potential slowdown” in momentum on Blackberry sales.

Wasn’t that prescient? NOPE. Not even close. But that doesn’t matter for McCourt, because I’m sure that his bosses came up to him that day and patted him on the back for being the catalyst for an eventual 25% price decline in the stock. I shouldn’t give him that much credit, as the short interest on the stock had been rising, and he could have been on the receiving end of a call from a large hedge fund that told him about the channel check “work” that the hedge fund had done, and the negative results that they had found. When you go to three or four AT&T and T-Mobile retail stores in Tennessee, you are bound to get incorrect information, and extrapolate from those wrong results. The momentum style hedge funds that were long the stock, began to sell it hard, as they never want to be the last one looking for a chair when the music stops. A few days ago, a rumor was circulated that RIMM would announce a restatement of earnings yesterday – another rumor likely started by hedge funds that were short the stock.

So what’s the bottom line? Yesterday, RIMM announced another blow out quarter, and RAISED guidance once again. The result? McCourt looks like Bozo the clown externally, but like a hero inside Morgan Keegan and to hedge funds that were short the stock.

Actually, there are lots of investors who also like the guy as he provided a HUGE opportunity to everyone who wanted to buy the stock at cheaper prices than existing prior to Dec 10. Unfortunately for Tavis, he has become a contra-indicator – so he is useful, but for the wrong reasons. Today, McCourt is quoted in a Businessweek story suggesting that the $99 Pearl units sold by AT&T actually helped RIMM. (Too bad that McCourt suggested on Dec 10 that the $99 price point was evidence that the carriers were discounting the units, and hence, would lead to poor results. Opps).

http://www.businessweek.com/technology/content/dec2007/tc20071220_523525.htm?campaign_id=yhoo

The people who really drive me crazy are the media types like Dennis Kneale at CNBC who pass themselves off as analysts and commentators of the sector. So what’s the hallmark of someone who is taking the opposing view, but hasn't done their homework and/or hasn't really thought about their view, and is desperately trying to sound erudite? They talk about valuation multiples, and base those multiples on TRAILING earnings or revenues rather than forward earnings. During an interview with Maria Bartiromo and Jim Goldman on CNBC after RIMM had reported their blowout results, Dennis kept trying to sound knowledgeable and skeptical about the “high valuation”, so told everyone that the stock was trading at 70x earnings. What he didn’t say was that 70x multiple was based on TRAILING earnings. EVERYONE knows that Wall St. prices shares based on forward earnings, so why do these clowns use trailing numbers? Obviously, they are trying to make their case – albeit, they do so rather poorly, and expose themselves as sophists. Barron’s does this too, so it’s really easy to figure out their motivation and their bias. The multiple on forward multiples was going to be much lower – as RIMM had just raised guidance for the upcoming quarter, and that would force the analysts to increase their full year estimates for the following year.

The real story here is that RIMM has become the dominant vendor of smartphones in the WORLD, and has virtually no competition. There will be competition as there always is, but there is none today. PALM has been a pretender for at least 5 years. PALM has an interesting unit developed by Handspring founder Jeff Hawkins, but it’s been exceedingly clear for several YEARS that PALM does not have the supply chain relationships to deliver large quantities of cell phones, and they don’t have the solid relationships with wireless carriers to pre-order units. Delivering PDAs and mobile phones apparently is quite different. I know that may come as a surprise to some of these guys.

Motorola continues to be in complete disarray as well, and has ceded its position as a legitimate competitor. What about Apple and iPhone? A nice unit, but it’s a fashion accessory rather than a legitimate enterprise class mobile phone for the business user. Nokia, Samsung, HTC, LG and others are trying to produce smartphones that compete with Blackberries, but their main business is in the 10-key units. Moroever, the smartphones of those vendors can connect to RIM's data centers, so RIM get a small cut of those revenues as well.

So where is the stock going? In a word – UP. In two words – WAY UP.

RIMM has only 12 million subscribers today, and it has only scratched the surface of the billion wireless subscribers worldwide. Wireless carriers around the world have a huge incentive to sell the unit to its subscribers due to the data plans that subscribers will purchase when they purchase a smartphone like Blackberry. GSM carriers like AT&T and T-Mobile generate gross margins in the range of 85% plus when they sell a data plan, and CDMA carriers like Verizon and Sprint generate 95% plus margins when they sell a data plan. In other words, selling a smartphone like Blackberry is incredibly more profitable to the wireless carrier than selling a standard 10-key mobile phone like the Razor.

Moreover, RIM has hundreds of deep relationships with wireless carriers around the world, so collecting pre-orders for units is a little like the scene in movie Trading Places where Eddie Murphy and Dan Ackroyd are standing in the orange futures pit taking orders from all the traders who had bet on the wrong side of the trade, and were trying to cover their positions. RIM execs have big smiles on their faces as they take the orders. The small difference is that RIMM activities occur as a result of years of hard work, and it’s legal.

Going forward, RIMM begins to ship units to China in large numbers, and the Blackberry 9xxx series will be released in the near term. This is going to be a $200 stock when RIMM releases their Q4 results in March. Where will Tavis’ bosses and the boo birds be then?

One final note: Just because the stock is up 100% on the year, is NOT a valid reason to be skeptical about future growth. In reality, it just could be that the company deserves to grow 100% per year, and deserves a premium valuation. WOW!! - what a concept.

RIMM - the battle of the analysts continues

I guess the phrase of the day should be "It's always darkest before the dawn."

Last Monday, Dec 10, Morgan Keegan analyst Tavis McCourt said wireless carrier T-Mobile USA lowered prices it charges for RIM's BlackBerry Pearl smart phone to $99 from $149, showing "that the Pearl is becoming a more mature product in smart phone land." He also said that that there was a "Potential" loss of momentum of Blackberry sales.

What a load of horse sh*t.

The stock began to drop from a high of $125 that morning as any momentum players in the stock would have unloaded their positions quickly. The stock has been as $97 as the overall market has had some problems with ongoing issues related to mess in the financial sector.
On November 20, Jim Balsillie (the Co-CEO of RIM) presented at the Scotiabank Tech conference (while the fire alarm was ringing in the conference facility). The first question was from the Scotiabank analyst, "Are you seeing any slowdown resulting from any layoffs in the financial sector. Balsillie's answer was "whatever impact we are seeing is dwarfed by the international sales. RIM's growth is coming from new channels in new markets (China, Russia, Eastern Europe, Latin America), rather than increasing penetration at large US financial services firms.

I guess McCourt didn't bother to listen to that call, as he was too busy with "channel checks" in the US market - which I guess really means visiting 3-4 AT&T wireless stores in the city where he lives.

So why did the Morgan Keegan note cause any issue? The "news" was two weeks old.
A few other Wall St. (and Bay St.) analysts began to chime in with their views.

This morning, a note from Goldman Sachs indicated that investor concerns around a weakening financial services IT spending environment have pressured shares down from the $125 level to $100. Goldman retained their rating at Buy and a $147 target price.

Citigroup says that the shares of RIMM were a very strong performer in 2007, and they think that RIMM is "the" stock to own for 2008. It is a pure-play in one of the fastest tech markets (smart phones) and should grow sales at 57% and see EPS growth of 66% in CY2008.

Consensus for the November 30 quarter is revenue of $1.65 billion, EPS of $0.62. RIMM is expected add 1.65 million subscribers this quarter ending November 30, though consensus for units shipped are in the 3.85 million range. Estimates for the February 2008 Qtr have edged down recently, but Citi thinks strong trends continue for RIMM into 2008, despite recent macro and financial services concerns. Citi reiterated its Buy rating and a $140 target price.

If we get in-line or slightly higher than expected results on Dec 20, the stock should remain at current levels as it has already taken a 30% haircut. I doubt that the shorts are done, but the stock closed at $106 on Friday, and it did trade as high as $109 , so it was apparent that many shorts were closing their positions in advance of the earnings, and going home with a nice profit.

On the Q2 earnings call on October 4, Balsillie indicated that the November quarter (Q3) would be the first time that RIM was being "featured" by the carriers for Christmas promotions. In other words, RIM would be filling the channel with units in anticipation of demand. This occurred in the US, Canada, and numerous European and Latin American countries that celebrate Christmas. Moreover, due to the timing of RIM's various quarter ends, and the recurring nature of their deals with the carriers, they have a pretty good idea how the quarter is going to turn out by the time they report the quarter. Their estimates for future guidance are pretty good - and they try to be conservative. As a result, RIM has been beating estimates and increasing guidance for the subsequent quarter.

Bottom Line: RIM will beat its published estimates for the November quarter. However, what will guidance be for the upcoming February quarter?

RIM begins to ship to China in December (so a full quarter of shipments there), so if RIM indicates that guidance is close to guidance for the November quarter - the stock will be back at $125 on Friday morning. If guidance is appropriate for a typical February quarter, then the stock may be below $100 again, and will slowly work up over the year as they execute on their fast growth. Last year, guidance for the February 2007 quarter was subscriber additions of 950,000 - 975,000. They reported 1.02 million subscribers for that February quarter. Therefore, my sense is that RIM's guidance will need to be about 1.35 million subscribers for the February 2008 quarter - which will be the same number as their guidance for the November quarter.

Moreover, it also seems likely that RIM will officially announce the upcoming Blackberry 9000 (a keyless unit comparable to Apple's iPhone). This unit will have to be available soon as AT&T has a new branded keyless phone made by HTC (China) using Windows Mobile, and looks much like the UI the iPhone.

In early October, the BGR website "leaked" news about the new BB 9xxx phone. It won't have the amount of hype and speculation an iPhone did before its release, but there is a great deal of anticipation about its upcoming release.

First off, the 9xxx will truly be a 3G device - unlike the iPhone which as advertised as 3G (meaning that data throughput will 1 Megabit / sec - or enough throughput to carry a full motion video conference call over the airwaves. IPhone works on EDGE, and EDGE is not 3G - and its not even as fast as Verizon's (and Sprint's) EV-DO data network which can handle burst speeds of 750Kilbits per second). The new BB unit will most certainly will have a 3G radio and we’re not talking about the European bands. (The actual 3G bands are not yet clear, but we can only assume North American 3G is a go).

Second, it will have simultaneous voice and data as the phone will be HSDPA - not that Wi-Fi fakery .

Third, it will contain a beefed up 600MHz processor!

And yet, RIM still doesn't sell any BB units in retailers such as Best Buy - but this I've known for years, but was somewhat surprised to learn that this continues to this day. I was out Christmas shopping earlier this week, and found that the wireless carrier booths in the middle of the malls were selling Blackberry units, but the biggest electronics retailer in the US still does not sell the units - and never has sold them (I spoke to a couple Best Buy salespeople about this, and they were sure that another store carried it, but they were unable to find it in their inventory system. I have never seen any Best Buy outlet sell Blackberries as RIM's deals are with the carriers.

However, imagine the sales if RIM did a deal with Best Buy - which is very unlikely.
RIM sells the units to the carriers for $300 or so depending on the model. As a result, the carriers subsidize the purchase of the RIM hardware to their subscribers, and then lock you into a 2-3 years contract - which is why you can get Pearls and Curves for $150 or less. The carrier is happy to subsidize the hardware because they can also lock the subscriber into a high margin data contract (this is how you get emails and internet access). Several years ago, the GSM/EDGE carriers like T-Mobile and AT&T were getting gross margins of 80% on data services. Verizon and Sprint (CDMA) were getting 95% plus. In other words, hugely profitable - and this has not changed.

T-Mobile began offering data plans at $10 per month last quarter, but for a limited amount of data throughput. Apparently, Smartphone sales began to increase quite nicely. Therefore, (and back to the Morgan Keegan note), if T-Mobile is offering Blackberries for $99 (from $149), then it seems logical to conclude that T-Mobile will be looking to sell a lot more very profitable data plans. Why would anyone assume that RIM take the hit on the price reduction? Just because other companies take the hit is not an answer. RIM has always done things differently, and has stuck to their deals.

So now it becomes a battle of the analysts. In one corner, a nobody from a regional firm who is trying to make a name for himself by calling a turn. In the other corner, the analysts from the national firms who have already "made it", and are trying to protect their client's positions.

Who made the better call? We'll find on Dec 20 when RIMM reports. However, you can be sure that the Research Director and the head of Capital Markets at Morgan Keegan came over and patted Tavis on the back, since his "Call" likely caused a bunch of sell orders that came through his firm.

The stuff that really drives me crazy is when the media pick up on negative stuff, and rather than do a little homework and run a balanced article, they simply get the negative stuff online to meet tight publishing deadlines. This intellectual laziness costs people tons of money, but at the same time, creates nice opportunities for those of us who can spend some time figuring out the truth vs. the sophistry and pure nonsense.

Recession: We are already there

I've been listening to all the talking heads on CNBC, blathering on and on, saying things like: "We're not officially forecasting a recession, but we see a slowdown." Blah, Blah, Blah.

What they're really saying is: "We won't have an officially NBER defined, two consecutive quarters of negative GDP growth. We see that the economy will slow down so that we will still show growth, but that it will be less than the "trend line" of approximately 3% per year.

What they really mean is that they are too chicken to out on a limb and say there will be a recession, so they take the safe approach – there will be a “slowdown”. Go and measure that one Bernanke.

So what's the bottom line?

House prices are falling in every part of the country. People are not taking out any more equity loans (as they have less equity in their homes), primarily because they are being turned down by banks. As a result, people will spend less. Since economic growth depends on consumers spending, we will have a recession. Moreover, as the media have been talking up this result ad museum, it seems pretty clear that we will soon have a self-fulfilling prophesy - the economy will slow down because people are spending less because they hear that everyone else is spending less.
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So now we have a sport of the talking heads forecasting a forecast. John Maynard Keynes would be proud.

As long as people continue to be employed, the depth of this recession will be minor. But make no mistake, we will have a recession. I doubt that we will have negative growth as the cheap US dollar helps exports, and US multinationals continue to do a nice job selling products overseas. But we should start calling it a recession. It also seems pretty clear that the length of this recession will be a based on how long it takes for the financial sector to work through the sub-prime slime mortgage crisis, and how long it will be before they can once again begin lending to people who will spend the money.

So how did we get into this mess? Let's say thanks to Alan (the fireman) Greenspan, and more recently, to the confused execution of Ben Bernanke and the Fed.

At this point, I think it's pretty clear that the issue is not whether we are going into a recession. The issue is how deep it will be.

Bernanke's First and Last Term

I've been having an ongoing discussion with a longtime friend (former classmate and colleague) who is an editor of a very well known financial services publication.

My view: Bernanke and the Fed are way behind curve on the economy, and their actions on Dec 11 have led to significant market confusion. The Fed should have lowered the discount rate by 50 basis points yesterday. My friend's view: the Fed is correct, (as they Fed had built up a lot of respect in the past with correct actions and moves), and they can lower the discount rate by 75 basis points in January - making the end point the same.

This morning, the Fed announced that they have been involved in the largest worldwide coordinated response to the worldwide liquidity fear since Sept 11, 2001. The Central banks of England, Canada and Switzerland will essentially work together to ensure that banks have the capital necessary to provide the credit markets with liquidity.

Unfortunately, the Fed completely bungled this announcement and have taken on the appearance of rank amateurs in doing so. As a result, the market has completely lost respect for this group of academics, and the chorus has already began: Bernanke needs to resign.

Yesterday, the Fed missed on three counts to "get ahead of the curve", and each miss was more significant tha the previous. Instead of lowering the discount rate by 50 basis points, they lowered it by 25 basis points. Strike one.

Last August, the Fed surprised the market with a 50 basis point reduction in the Fed funds rate. Many commentators have suggested that current conditions in the credit markets are as bad, if not worse, than conditions were last August. Therefore, the market was expecting another 50 basis point reduction in the Fed funds rate today. Nope - we got 25 basis points.

Strike two. The statement pointed to a concern about rising inflation rather than a faltering economy on the knife's edge of slipping towards a recession. This was the most grievous mistake. Strike three.

So the markets (the Dow) immediately begin a death spiral selloff, and was down by 300 points by the end of the day. Within the first 30 minutes, the financial sectors stocks and housing sector stocks began the plunge. Most interestingly, key tech stocks held up very well in those first thirty minutes. However, within an hour, the tech stocks which had been performing extremely well all year (due to their superior results and execution), began to mirror the slide down, and most were 3%-5% lower by the end of the session. Obviously, as a fund manager, if one side of the portfolio is experiencing a massive slide, you need to begin selling your winners to raise cash, so you sell the most liquid names first.

I guess the worst part of the day was a "Breaking news" announcement from Steve Liesman of CNBC, who came on the air to announce that a confidential source at the Fed had contacted him to say that "the Fed can do more, and an announcement was coming soon."

Huh?

After spending several weeks of trying to wean the markets off of "automatic" rate cuts, and saying that the Fed will react to market conditions as market conditions warrant, the Fed was reacting to the tantrum being thrown by a child (the market).

So what happened this morning?. The coordinated effort announcement. The markets initially took this as good news since it was obvious that they had been working on this coordinated effort for some time. However, as the day progressed questions about this action began to emerge, and the markets began another downward move. The most significant questions related to the execution of the announcement: first a confidential phone call to Steve Liesman at CNBC in an effort to calm the markets, and then the announcement the next morning after the other central banks had been properly and officially consulted about the public announcement. Second, while the announcement focused on easing the ongoing seizure in credit markets, it said nothing about the greater fear of an upcoming recession. And the selling began.

By the end of the day, I heard that Dennis Gartman was openly calling for the resignation of Bernanke.

The market also came to the realization (though this happened almost immediately), that their execution is better characterized as amateur hour – you know, like Sangia (on American Idol). He started out sounding great, but then hit some major flat notes – and then was mocked by everyone.

They cut interest rates – but oh yeah – they left off some key comments about risks increasing on the economy – and they left off the comment about working on a worldwide solution (they didn’t have to provide specifics, just say something else is in the works).
They gave themselves a big black eye this week, and it will take quite some time to heal, and regain the respect of the market. At this point, it looks very bleak, and the market has completely lost respect for these guys.

Conviction about a solution will help with market psychology, but it appears that the Fed is contributing to a recession by being wishy washy and incompetent about the execution.

My friend at the financial publication shared a comment sent to him by a longtime client.

"I think (your publication) assumes that the Fed will get it right. With this regime, I would not make that assumption.

I think that a Fed Chairman with his academic background and all his personal money invested in TIAA CREF (like a paint by number book for investors) is not likely make good practical decisions under this level of stress. And his team seems likewise confused.
The most dangerous day in (Canadian) hospital's intensive care unit is July 1 - (the Canada Day holiday). That is when they turn the newly graduated doctors loose to treat patients independently. The patients are gravely ill and the new doctors are gravely inexperienced. The results are largely predictable.

My bet - the Fed is missing a major turn. This is the first time I think you might be wrong -your line of reasoning is logical as the Fed has never been so incompetent and they have your implicit respect.

I hope you are right that things will turn out fine. They will, but I think not soon. I believe I see a new intern in my ICU and it is Canada Day".

Bottom Line: Led Zepplin is currently on a "comeback" tour. They lead off with the Fed's new theme song: “Dazed and Confused”. Now we have to worry about Fed figures out whether the second song is “Stairway to Recession.” – or was it Heaven?