Is BlackBerry A Takeover Target?

The last few years have been huge for the Canadian company Research In Motion (RIM), the manufacturer of the once loved Blackberry phones. We don’t need to go back more than 4-5 years to see how popular the Blackberry system was, dominating the smart phone market and guaranteeing huge profits for its maker. At that time, future prospects were so good that the company’s stock was trading at more than $150. But, unfortunately for RIM, technology changes fast and consumer preferences even faster. The Android system emerged and Apple entered the market with its iOS system, and now the new Blackberry is probably the iPhone. In a matter of a just a few years, RIM has lost almost its entire market share and its shares take a dive to as low as $6.

Resting on its popularity, RIM wasn’t able to innovate as Google and Apple did and bankruptcy was avoided just because the company still had some loyal institutional clients paying subscriptions fees. Thorsten Heinz, the company CEO restructured the company and bet the whole ranch in a new generation operating system, the BB10. After many delays the new system finally arrived at the end of 2012.

With Blackberry once the top preference of smart phone users and with all the hype around the BB10 launch, expectations were huge. From a low near $6 in September last year, RIM’s shares rose to $18 at the beginning of this year. Reports of phone shortfalls to satisfy initial demand amplified the theory pointing to a strong brand rebirth. RIM sold 1 million units of its new phones in just one month and that with very limited availability. The data was strong enough to help shares rise.

For smarter trades subscribe to Tradespoon!

But as the phone became widely available and a full quarter of sales was on record, what seemed like strong sales, turned into deception. A few days ago RIM reported dismal quarterly earnings. Revenues are up from $2,677M to $3,071M QoQ but the company showed a loss of $0.16 per share. The company is eroding its margins and the worst deception was in the 2.7 million phone units sold in an entire quarter. After waiting more than a year for BB10 and with management betting the ranch on it, investors were looking for much more than roughly a million units sale per month. RIM shares were severely wounded declining 27% in a single day and from $15 a few weeks ago are now at just $9.21.

There’s no doubt it will be tough for RIM to put the Blackberry phone back on track. The launch of BB10 comes too late and the company is in need of a plan B now. Investors are valuing the company at half its book value as they expect the company to burn its cash reserves and working capital in a frustrated attempt to market its phones and operating system. RIM’s market cap is now $4.8 billion, which is a steel for a company with $2.8 billion in cash, more than $3 billion in patents and net assets of $9.4 billion. If the company were to be sold at just book value, its stock should be valued at $18.24 instead of the current $9.21.

There are two options for RIM right now. The first would be to continue its operations as a going concern trying to be more cost effective. RIM is the best in terms of security features when comparing with the competition and the best tailored for institutional clients, companies, and even governments. If the company manages to improve its gross margin to Apple’s level near 44% (something they were able in the past), then last quarter earnings would have been a profit of $0.42 per share instead of the $0.16 loss. The second alternative is an outright sale of the company. With the market organized as a duopoly between Android and iOS, some companies may find here an excellent opportunity to enter. At the same time, the stronger smart phone makers may wish to diversify risk. Equipping part of their phones with Blackberry may be the way to go.

With all this in mind we believe this is an excellent opportunity to buy RIM’s stock, or to expose to it through call options. We particularly like call options expiring in January 2014 as they give us sufficient time to wait for some takeover bid. To get the most out of it, we prefer slightly out-of-the-money calls. They’re cheaper, allowing us to minimize downside risk while still having a huge upside. We suggest calls with exercise price of 9.00 and 10.00. Currently valued at 1.27, the January Call at 10.00 would rise to more than $8 if RIM’s stock rose to its book value at $18.24. That’s an excellent proposition!

For smarter trades subscribe to Tradespoon!