Analyst Silliness with Research in Motion

In recent days I have been paying special attention to shares of Blackberry maker Research in Motion (RIMM). The stock is one that had decent earnings this quarter but some investors wanted more, which prompted a pretty significant sell off in the stock. Despite the market having recently made new yearly highs, RIMM shares have dropped from the high 80's to the mid 50's. The stock is down several points today after the analyst who covers them for Citigroup downgraded it from "buy" to "sell."

Skipping the "hold" rating completely is pretty rare on Wall Street, but what caught my eye even more was that the analyst lowered his price target on RIMM from $100 to $50. What happened to make the company worth 50% less overnight in his view? The upcoming release of Motorola's Droid smart phone.

Call me skeptical of this bold call from Citigroup's research department. The new Droid is going to be such a huge success that it will translate into a 50% haircut in the value of Research in Motion, which has a stronghold on the corporate smart phone market? Have we not seen dramatic hype surrounding new cell phones recently that only served to disappoint investors? The Palm Pre comes to mind immediately. While it may help Palm get back on the map, the Pre is certainly not looking like a genuine iPhone challenger like many were expecting. Should we believe that the Droid will similarly make a huge dent in RIMM's Blackberry franchise?

I haven't made the plunge into RIMM stock yet, but the odds are getting higher each day the stock continues to slide. At a current $55 quote RIMM trades at 11 times 2010 estimates ($4.85 per share), which seems reasonable even if that figure proves too high due to increased competition. Right now I might just be willing to make the bet that the Blackberry retains its lead in the corporate market for years to come. If so, the stock looks pretty cheap here.

How have this analyst's past calls on the mobile sector turned out? Pretty lousy, which is par for the course on the sell side. Today the analyst upgraded Motorola to a buy and downgraded Palm and RIMM to sell. He initiated coverage for all three back in September 2007. Here is how the calls since then have turned out:

His track record on Palm has been decent; initiated at sell at $8, upgraded to hold at $6, and now back to sell at $11.

How about RIMM? Dismal. Recommended as a buy twice at $99 and $69, and now says you should sell in the mid 50's.

Lastly, the Motorola record isn't all that impressive either; hold at $18, buy at $12, hold at $6, buy today at $9.

All in all, the current negativity on Research in Motion looks overdone to me and as a result I am considering a contrarian investment. As always, please share your own thoughts if you care to join the discussion.

Full Disclosure: Peridot Capital had no position in RIMM at the time of writing, but is certainly taking a very close look at current prices.

Google Recaptures 5th Spot On Most Valuable U.S. Companies List

Nearly two years ago I wrote about internet search giant Google (GOOG) seeing its stock price surpass $700 per share, and as a result, become the fifth most valuable U.S. company in terms of equity market value. Shortly thereafter the recession hit and Google shares tumbled with everything else. The stock is making a comeback though, after reporting strong third quarter earnings last night. Analysts are once again very bullish, boosting their target prices today.

With the stock up $21 today, Google has reached $550 per share and has now returned to fifth place on the most valuable company list, as you can see below.

My main question has not really changed over the last two years. Does Google deserve to be number five, or will we look back five or ten years from now and realize that being a leader in internet search and advertising (while certainly an impressive feat) doesn't really translate into a company being valued nearly the same as some of the others on this list.

Full Disclosure: Some Peridot clients have been long Google over the last two years, and some still own it, but I have been cutting back the positions as the stock's forward P/E ratio has gotten back over 20 (currently about 22).

Introducing Smartphones Unlikely To Save GPS Hardware Firms Like Garmin

Many investors often confuse good products for good stocks. Surely the two can go hand in hand, but that is not always the case. Although they make great products, I am wary of standalone GPS hardware companies such as Garmin (GRMN). With smartphones quickly becoming multipurpose devices, including GPS, the market for standalone GPS devices is likely going to suffer from lower unit volumes and even more importantly, pricing pressure in the not-too-distant future.

There is no doubt that I envision a time five or ten years from now when all new cars come equipped with GPS in their dashboards, but the odds of price erosion not playing a role in such volume increases are slim. Companies seem to understand this likely future trend. In fact, Garmin is getting ready to launch its own smartphone to get into the GPS-enabled cell phone market. I feel comfortable predicting a Garmin phone will not be very successful.

The longer term trend will likely result in unimpressive volume growth for standalone GPS devices and large price cuts. It is very difficult to maintain profit margins at reasonably high levels when a service like GPS becomes commoditized and available through additional channels. With such market dynamics, it is reasonable to expect revenue could rise while profits actually fall, which would severely hurt the stock prices of GPS device makers like Garmin.

The stock today, fetching more than $31 per share, isn't all that expensive on an earnings basis (~12.5 times 2009 estimates), but it is the profit estimates that I would be worried about. In fact, the consensus thinks GRMN's earnings will drop 12% next year, on flat sales, so people do realize Garmin faces headwinds going forward.

The price-to-sales multiple on GRMN would worry me further if I owned the stock. Hardware firms typically have low profit margins and thus low revenue multiples (Apple is a rare exception because their brand and unique product lineup fetch higher prices), but Garmin trades with an equity market value of $6.34 billion, which is more than 2.3 times revenue of $2.7 billion. That is a high sales multiple for a hardware company.

Garmin's strong balance sheet ($1.5 billion in cash, no debt) likely contributes to the loftier-than-average valuation, but no amount of cash will be able to change the market dynamics for GPS device companies in coming years. If I owned GRMN stock I would closely monitor the situation at the very least. If I was looking to pair some shorts up with longs in the technology space, GRMN would be one to consider in terms of firms facing technological and pricing headwinds over the intermediate to longer term.

Full Disclosure: No position in GRMN at the time of writing, but positions may change at any time

Yahoo! Accepts No Cash Upfront As Microsoft Search Deal Is Finally Reached

Eighteen months ago Yahoo (YHOO) management rejected a $33 per share, $47.5 billion cash takeover offer from Microsoft (MSFT). Today the two companies have announced a search partnership that makes Microsoft's Bing the default search engine on Yahoo and gives Yahoo no cash upfront for the privilege. This story is likely one of the worst executive management screw-ups in U.S. corporate history.

Yahoo shares had traded up to $17 each on anticipation of a deal with Microsoft but are trading down sharply today after the actual terms were announced. Yahoo will receive 88% of search revenue, while Microsoft will keep 12% for providing its technology. Yahoo saves money by not having to run its own search technology.

Who wins with this deal? Both companies, but Microsoft more so. Bing instantly increases its global market share from 6% to 15% by being incorporated into Yahoo's sites. That still pales in comparison to Google's 81% global share, but there is not much more room left to conquer now. Microsoft still makes some money here, even only keeping 12% of revenue, because market share has risen by 150% overnight.

Yahoo estimates that its annual operating cash flow will rise by $275 million from this deal, but it will take two years to be fully implemented. At their current valuation, that means about $3 per share of value creation, a far cry from the $14 of value creation ($33 cash versus $19 stock price at the time) that was offered by Microsoft and subsequently rejected as "undervaluing the company."

And remember, these numbers are Yahoo estimates so they are going to be overly optimistic. A lot can change in 24 months, which is how long they think it will take to revamp these operations and integrate both companies into this new search structure.

Does this deal hurt Google (GOOG)? Not really, in my view. Do they care who has the 19% global search market share that does not flow through Google sites? Probably not, unless they really think Bing is so good that it will lure search queries away from them.

Given Microsoft's history on the web, and with search products more specifically, it is hard to fear Bing, even if it has Yahoo as a partner now. Aside from Xbox, Microsoft has had little success diversifying away from Windows based operating systems and office software products. Putting two mediocre online players together is unlikely to have a dramatic effect on the industry landscape, although it will save each some resources.

As for the stocks, Peridot Capital has small positions in all three. Microsoft appears the most attractive at current prices, as Google is approaching fair value. Yahoo is less appealing now that an outright takeover by Microsoft is less likely. They could possibly come after the rest of Yahoo at some point in the future, but owning the stock for that reason solely is not very intriguing.

Full Disclosure: Peridot Capital was long shares of GOOG, MSFT, and YHOO at the time of writing, but positions may change at any time.

Update: Smart Phone Makers Ripe for Profit Taking

Earlier this year I wrote separate pieces highlighting both Research in Motion (RIMM), maker of the Blackberry and smart phone staple, and Palm (PALM), the turnaround story trying to get their name back into the mix. In the four months or so since then both stocks have soared, nearly doubling in each case (PALM from $6 to $11 and RIMM from $44 to $78). Not surprisingly, these are instances when taking profits makes sense.

The competitive landscape for Research in Motion really hasn't changed since February. The stock move is based on two things; the overall market advance, as well as renewed optimism that Blackberries remain popular devices and profit margins will hold up nicely even in this heightened period of competition and economic challenges. RIMM has seen its P/E ratio on 2009 earnings estimates jump from a very meager 13 times to a more reasonable 20 times, which seems more appropriate to me.

In Palm's case, the stock has moved in anticipation of their new device, the Pre, set to debut June 6th. While the prospects remain bright for both the Pre and subsequent devices Palm is sure to launch in coming quarters, we often see a sell off in the stocks of tech companies heading into or right after major product releases (so called "buy the rumor, sell the news"). In order for Palm shares to make new highs above the recent peak of $14 $12 per share, the Pre launch really must go perfectly. However, as is the case with many new product launches, expectations are high and there can be hiccups along the way. Therefore, there will be opportunities for investors with big gains to take profits and put selling pressure on the stock.

In both of these cases, investors who have sizable gains and still believe in either or both of these companies longer term can have their cake and eat it too by taking some chips off the table and keeping a smaller position to profit from if their instincts are right about the future.

Full Disclosure: Peridot Capital was long shares of Palm at the time of writing, although the position has become smaller in recent weeks, and positions may change at any time

Dell Shares Look Excessively Cheap

It has been a long time since I can recall seeing a blue chip company like Dell (DELL) carry such a meager stock market valuation. It is true that Hewlett Packard (HPQ) has been stealing market share from Dell in recent years, and even overtook them as the world's leading computer maker, but investors seem to be pricing Dell stock as if they are no longer relevant in the computer hardware marketplace. Given that Dell remains number two worldwide in PC shipments, I think pronouncements of their death may be greatly exaggerated.

Just how cheap are Dell shares? Well, Dell currently has about $8.8 billion of net cash on their balance sheet, which equates to nearly half of their share price ($4.50 per share in net cash versus a stock price of $10 and change). Total cash of $5.50 per share (excluding debt) is more than 50% of their current share price. I can't name another profitable blue chip company that trades at just two times net cash.

Given the low stock price, Dell's operations must be going horribly wrong, right? Well, not really. For their latest fiscal year, which ended January 31st, Dell earned an operating profit of $3.2 billion. Subtract out income taxes and Dell's operating businesses are earning about $2.4 billion per year. This compares very favorably to their enterprise value of around $11 billion. At $10 per share, Dell stock trades at less than 5 times operating earnings. Is it a stretch to think it could fetch twice that price sometime down the road? Not in my view.

Now, something could certainly get in the way of this analysis. Excess cash is a great thing to have, but it can easily be wasted by management. Dell has been doing many smaller acquisitions in recent years to beef up its product line. If management did a large deal (using their cash war chest) and it turned out be a bad idea, shareholder value could be destroyed rather quickly.

Another risk is that they use their excess cash to beef up research and development. I say this could be a negative because the new products might not pay off. For instance, there have been rumors for months that Dell is developing a cell phone line. As a shareholder, I don't care for this idea. The cell phone market is crowded and Dell has no experience in it. If they spend hundreds of millions on something like that, and it fails, a once large cash hoard could quickly shrink without much to show for it.

Regardless, Dell stock looks very cheap to me, especially if management spends their money wisely in coming years. Finding such strong companies at discounted prices isn't always easy, but in this case Dell looks to be a bargain. Feel free to let me know what you think.

Full Disclosure: Peridot Capital was long shares of Dell at the time of writing, but positions may change at any time.

Time Warner Completes Cable Spin-Off, Sets Stage For AOL Split Next

Time Warner (TWX) has long been a media conglomerate difficult for investors to dissect. However, that may be about to change and the moves could finally extract some value for Time Warner shareholders. The company will complete its spin-off of Time Warner Cable at the end of the month, which offloads billions of debt to the cable company and frees up cash flow at TWX.

Time Warner is also making some moves at its AOL division. AOL has hired Tim Armstrong, formerly the head of U.S. sales at Google, as its new CEO. The conventional wisdom is that Time Warner will spin off AOL as well, in order to allow Armstrong to maximize profit and growth potential at the online unit.

All of this should be good news for Time Warner shareholders, whose stock has been cut in half over the last year and sits near its lows. Time Warner retains some very strong brands, including HBO. With less debt from the cable division, coupled with a $9 billion cash infusion from the spin-off and a new strong management team at AOL, investors might finally begin to look at the stock again in the intermediate term.

As a result, bargain hunters who prefer strong large cap companies might be interested in checking out TWX shares at $8 each. Not only do they sit near their lows, but they yield 3% and trade for less than 5 times trailing cash flow.

Full Disclosure: No position in TWX at the time of writing, but positions may change at any time

Research in Motion Options Scandal Is A Non-Event

Shares of Research in Motion (RIMM), maker of the popular Blackberry line of smart phones have fallen to $44 per share and the latest news is that the SEC has reached a settlement with RIM executives over an options backdating scandal. I thought options backdating was over and done with, but evidently there are still some cases that have yet to be resolved.

A lot was made at the time options backdating came to light, and the practice is certainly unethical, but it really will have no impact on the company's business. RIM shares are down 70% from their highs and now trade at only 13 times current year earnings estimates. If you think Blackberries are here to stay, the weakness this week, in part due to the options headlines, is giving investors an interesting entry point.

Full Disclosure: No position in RIMM at the time of writing, but positions may change at any time

Amazon Shares Look Expensive, Long Term Future Returns Appear Limited

In November of 2004 I wrote a piece entitled "Sleepless in Seattle" which postulated that shares of Starbucks (SBUX) were trading at such a high valuation (forward P/E of 48) that even if the company grew handsomely over the following few years, the stock's performance was likely to be unimpressive. I projected an aggressive three-year average annual earnings growth rate of 20% and a P/E of 40 by 2007. I warned investors that even if those aggressive assumptions were attained, Starbucks stock would only gain 6% per year over that three year period.

The analysis proved quite accurate. Starbucks continued to grow its profits nicely, but the stock's valuation came back down to earth. After three years had passed, Starbucks stock was actually trading 12% lower than it was when I wrote the original piece.

Today, shares of online retailer Amazon.com (AMZN) remind me of Starbucks back in 2004. Despite a cratering stock market and weak retail market, Amazon stock has been quite resilient. After a strong fourth quarter earnings report (released yesterday after the close of trading), the stock is up $7 today to $57 per share. Profits at Amazon for 2008 came in at $1.49 per share, which gives the stock a P/E of 38, which is very high, even for a strong franchise like Amazon.

I decided to do the same exercise with Amazon. I wanted to make assumptions that were both reasonable but also fairly aggressive. I decided that an average earnings growth rate of 15% over the next five years fits that mold. Projecting the P/E in January of 2014 is not easy, but given that Amazon's growth rate should slow as the company gets larger, I think a 20 P/E ratio is reasonable given where other retailers trade (less than 15x). By 2014, Amazon's growth rate should be more in-line with other retailers similar in size, so I chose 20 to be higher than average, but not in nosebleed territory like the current 38 P/E.

After some simple number crunching, we can determine that Amazon would earn $3 per share in 2013 in this scenario. Twenty times that figure gets us a share price of $60, versus today's quote of $57. Even if the company hits these assumptions, shareholders will make a total return of 5% (only 1% per year!) over the next five years. I would be willing to bet the S&P 500 index far outpaces that rate over that time.

Obviously these assumptions could prove inaccurate, but I think this exercise is helpful in illustrating how hard it is for stocks that trade at lofty valuations to generate strong returns over the long term.

There is one interesting thing about Amazon's business that I think is worth pointing out. You may recall that one of the bullish arguments for an online retailer like Amazon was that they could have a lower cost structure by eliminating the expenses associated with renting and operating large brick and mortar storefronts. Having a 100% online presence was supposed to result in higher profit margins, and therefore investors could justify paying more for Amazon's stock.

It seems that argument has not been realized. Amazon's operating margins in 2008 were 4.3%. If we look at brick and mortar retailers that are similar in business line and/or size, we find that Amazon's margins are actually lower than their offline competitors. Here is a sample list: Kohls (KSS) 9.9%, JC Penney (JCP) 7.6%, Macy's (M) 7.2%, Target (TGT) 7.8%, and Best Buy (BBY) 4.6%.

Maybe online retailers have to spend more on research and development and call center staff than offline stores do, thereby cutting into the margin advantage. Amazon also offers free shipping on orders of $25 or more, which many say they could eliminate to boost profits. Maybe so, but sales would be affected to some degree if they did that, not to mention customer loyalty.

Nonetheless, to me these statistics help make the case that a 38 P/E for Amazon is way too high. As a result, returns to Amazon shareholders over the next several years could very well be unimpressive, just as was the case with Starbucks five years ago.

Full Disclosure: Peridot Capital was long Best Buy and Target at the time of writing, but positions may change at any time

Two Suggestions for Apple's Board of Directors

As an Apple (AAPL) shareholder, the recent handling of disclosures regarding the health of CEO Steve Jobs has me upset like most other investors. For some reason, Apple's board of directors believes that a CEO facing a potentially fatal cancer is not "material" piece of news.

They didn't tell us right away when Jobs was diagnosed with pancreatic cancer several years ago, despite a five year survival rate of less than 50%, and they have refused to update us on his health. Now we have to rely on tech-related blog sources to update us and when finally forced to give more details, the Apple board said he was fine, only to announce his six month leave of absence days later.

As if this is not difficult enough for shareholders, the company is currently sitting on $28 billion of cash in the bank. Apple's cash hoard would rank it the 55th most valuable company in the S&P 500 even if it had no operations whatsoever. Why on earth is Apple keeping this much cash on its books?

They will tell you they want to keep money available to make strategic acquisitions and to weather economic downturns. Has Apple ever made a large acquisition? Did they not just announce better than expected earnings for the fourth quarter despite this severe recession? There is simply no reason for them to have $28 billion just sitting there.

I have two suggestions for Apple's board of directors. Not only will both moves boost Apple's share price, but more importantly it would simply show some desire on their part to be fair to their shareholders, the same people who pay their salaries.

1) Announce a Management Succession Plan

How hard is this, really? Apple has plenty of competent managers. All the board has to do is announce what the management hierarchy would look like if Jobs left the company for personal reasons. With that knowledge in hand, he can stay as long as he wants as far as I'm concerned! The board knows this is a crucial issue (the stock plummets each time the health issue appears troubling), but simply ignores it for some reason.

Personally, I do not believe that a Jobs-less Apple would be in trouble. The idea that he is the entire brains behind the company and its products, and not the other 35,000 employees is pretty silly. Jobs is certainly a very good CEO, but the idea that Apple lacks the talent to innovate without him seems far fetched to me.

2) Announce a Stock Buyback Plan and Repurchase 20% of the Company

At current prices they could retire 20% of the company's outstanding shares and still have $12 billion of cash in the bank (and that number would grow every quarter from there). Can anyone really make the argument that Apple needs more than $10 billion of cash? I guess if you think they are going to buy Dell for cash or something than you could, but large tech acquisitions rarely are successful and more importantly, Apple has no history of even attempting them. A large buyback would be significantly accretive to earnings per share and could get the stock rolling again after the latest Jobs-related hiccups.

Neither of these moves would hamper the future outlook for Apple whatsoever. They would simply show that the board of directors is actually doing their job; working for the shareholders of the company.

Full Disclosure: Peridot Capital was long shares of AAPL at the time of writing, but positions may change at any time