Saturday, June 25, 2011

analyst, Why does RIM trade at five times earnings (June 27, 2011)

With Research In Motion Ltd. (RIM-T28.23-0.91-3.12%) shares trading at about five times estimated earnings, bullish investors need only point to the compelling valuation to make their case. After all, rival Nokia Corp. (NOK-N5.88-0.14-2.33%) trades at about 20 times earnings, and it is facing even bigger competitive struggles than RIM.

So how do bearish observers respond? Pierre Ferragu, the analyst at Sanford Bernstein who recently cut his target price on RIM to $20 (U.S.) from $40 and has been bearish on the stock for the better part of two years, argues that RIM’s prospects are deteriorating so quickly that the price-to-earnings ratio doesn’t mean a whole lot.

First of all, management’s guidance implies that pricing power is falling sharply: The gross profit margins on devices will collapse in one quarter to 24 per cent from 33 per cent, which is below the analyst’s expectations for Nokia.

“The only reason why RIM is still delivering a higher level of earnings is the highly profitable service fee it charges every month to BlackBerry users,” Mr. Ferragu said in a note. “But how sustainable is this, if anyway RIM’s value proposition got so weak that handsets cannot be sold at a higher gross margin than Nokia phones?”

“As the situation continues to deteriorate for BlackBerry, we believe the market will stop looking at RIM’s profit-based valuation metrics, hence the still significant downside potential we see in the stock.”