Needham & Co. analyst Charles Wolf thinks Research In Motion is deluded in its guidance, slamming the firm with an under-perform rating on strength of increased competition from the iPhone and other manufacturers.
Wolf despatched the following message to clients today: “RIM reported second quarter results in line with guidance. The major disappointment was guidance going forward – the prospect of lower gross margins extending through 2010. We believe the company is fooling itself in ignoring the increasingly hostile competitive environment. We’re maintaining our under perform rating and reducing 2009 and 2010 earnings estimates. ”
RIM reported second quarter earnings of $0.86 on revenues of $2.58 billion, virtually in line with guidance. The big disappointment was guidance going forward. Because of a rapid product introduction cycle, RIM is guiding to a gross margin of around 47% for the third and fourth quarters. Nor does the company expect its gross margin to materially improve in fiscal 2010.
In their conference call, management dismissed the notion that new competitors, most notably Apple’s iPhone 3G and new smartphones running on Google’s Android platform, would materially slow the growth in new subscriber activations. We continue to believe that the company has its head in the sand. Yes, the iPhone and Android phones will expand the market as they lure mobile phone users to smartphones. But we believe it’s delusional to think they won’t cut into BlackBerry sales as well, especially in the consumer market.
Consequently, we are maintaining our under perform rating on the stock because we believe there’s risk to RIM’s top line growth in addition to its gross margin.
We’re reducing our 2008 earnings estimate from $3.70 to $3.50 and our 2010 estimate from $4.80 to $4.65. We’re also cutting our fair price from $90 to $84 on the assumption of a lower operating margin. However, we view our valuation calculation as irrelevant given the fundamental risks in the RIM story.”
His summary notes also included some interesting nuggets:
“What’s telling in this regard is that the sleek, easy-to-use BlackBerry Pearl had the consumer market pretty much to itself throughout this period. Motorola, Samsung
and HTC all made valiant attempts to enter this market. But all three smartphones ran on the justifiably maligned Windows Mobile operating system. The Windows platform has been consistently damned as the most difficult-to-use operating system on the planet.”
“the days of no competition are over. They ended with Apple’s July 11th launch of the iPhone 3G. Two obstacles limited sales of the first generation iPhone. First, when not in WiFi hotspots, the iPhone ran on AT&T’s sluggish Edge network. Second, the $399 price point for the 8-gig model was simply too high to gain much traction. The iPhone 3G overcomes both obstacles. It runs on the much faster 3G network. And its subsidized $199 price positions it squarely in the sweet spot of the smartphone market.
With the iPhone 3G, Apple took two additional steps. First, it dramatically increased its addressable market. Apple sold the original iPhone in only four countries—the U.S., the U.K., Germany and France. The iPhone 3G will be sold in 70 countries by year end and possibly more if Apple’s negotiations with China Mobile are successful. More importantly, Apple opened the iPhone to software developers when it released a software development kit on March 6th.
“The lock-in effect the iPhone software creates should insure a staggering installed base for the device. Apple sold over one million iPhones in its first weekend on the
market; and the company could ship over five million in its September quarter.”
Research in Motion will also have to contend with other entries in the smartphone space, including Android, “which promises to not only challenge the iPhone econ-system but could also cut into BlackBerry sales in the consumer market,” the analyst added.
And, of course, Nokia plans to introduce its own family of smartphones before Christmas, the analyst added, “So, if anything, the competitive landscape has become much more hostile than it was when BlackBerry was chalking up triple-digit gains in the consumer segment of the market.” he said.
Noting that RIM is fighting back with at least three new models, the analyst says that while he doesn’t expect the manufacturer to suffer in the enterprise market, he does anticipate that consumer market sales could shrink in the face of such stiff competition.
Wolf also notes the counter argument that the smartphone market is growing so rapidly that it can easily accommodate several winners, including both RIM, Apple and possibly Android, but warns that growth in smartphone shipments slowed to 28% in the second quarter from 52% in 2007 and triple-digit growth in the early years of the decade.
“We believe that the iPhone 3G will cause growth to reaccelerate in the third quarter and beyond. But it would defy a fundamental law of economics to conclude that all iPhone 3G sales will result from subscribers abandoning the feature phone market. In our opinion, the iPhone is bound to capture some sales from consumers who might otherwise have purchased a BlackBerry. We believe that Android smartphones will also expand the smartphone market but also capture some market share from the current participants in this market including BlackBerry.”