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2011-12-16 09:00 by Karl Denninger
in Company Specific , 1 references Ignore this thread
A Tale Of Two Whalloped Stocks

RIMMber reported last night and, well..... RIMMber is the right word for the market's reaction.

We're talking about a stock that, at present price, looks to be earning about $3.20/share next year and yet is selling this morning under $14.  That is, it's selling at 4x earnings.

And the earnings are real folks.  So is the fact that the company is generating free cash from operations; there's no indication that this is not the case (provided you don't believe the firm is falsifying their balance sheet outright, and I don't) which is ultimately the test for a company's ability to remain around.

You take the inventory write-down on the Playbook out of the mix and the EPS last quarter was $1.20; that's nearly $5/share in EPS annualized, for a P/E on an adjusted basis of about 3!


Simple -- the belief is that the Blackberry is finished in the marketplace.

Not so fast folks.

I want to ask the Android apologists one question: How many of you have ever looked inside the code?  I ask specifically because I have -- and because I was one of two guys who (together) ported CM7 to the Motorola Triumph. 

Let me give you my professional opinion as a coder who's worked on projects small, large, huge and stupendously-sized over the years: Android is a mess.

This doesn't mean it doesn't work, of course, because it does.  Well, mostly.  But it's poorly documented externally, with huge portions of the available "open" documentation either missing, withdrawn intentionally by Google or simply wrong.  The internal (e.g. in the code comments) are even worse -- if you can find the one or two comments and definitions, that is.

This sort of alleged "code quality" isn't all that uncommon among commercial software.  In fact the disturbing part of it is that this is more the rule than the exception.  I don't know what IOS looks like internally, since it's not open source, and of course I have no idea what sort of ball of spaghetti BlackBerry's code might resemble either.  But I do know what Android looks like inside, because I've seen it, I've worked on it and I've ported it.

Now let me point out a few more things.  There's a second device I got interested in for CM7 (actually two more.)  These are from a different manufacturer.  And in them, there's a new issue -- the port appears to work fine (that others put together) except for one small problem -- if you dial 911 the call connects but there's no audio.

You might think this is not a huge deal.  You'd be wrong.  A "dead air" call to 911 is a potential disaster in the making, because the dispatcher is likely to conclude that you can't answer (e.g. you're having a heart attack, etc) and roll assets to where they think you are.  Maybe lots of assets.

So why does that problem exist?  Because there is no consistent interface enforced nor is there any documentation in a clear and concise format on the RIL (radio interface) that everyone obeys.  As such there's obviously a call that's undocumented and missing that is used by this particular manufacturer to do the "right things" (possibly including trying to turn on the GPS and stuff the coordinates for the 911 system too) that is unknown to anyone but them.

That's sort of a problem, you see.

Now let's talk about one of the others: Email.

For many business users the cellphone isn't something to look up when the next movie is playing, or to play Angry Birds.  It exists mostly as a communication device to send and receive emails and text messages -- and synchronization with the corporate environment is a big deal.  This is where the Blackberry wins -- still -- and nobody is seriously doing anything about that.

Android's provided email client may be fine for Google email (Gmail) and their other client for other accounts somewhat passable.  But I'll tell you this right now: For corporate users -- whether on open standards email systems (IMAP4 in particular) or proprietary ones (Exchange) it blows.

There's a solution to this (which I use) in the application space called K9 mail that works very well with IMAP.  But that's an add-on.  And "push" email support is not optional in the corporate environment. Nor is, for heavy messaging and email users, a keyboard.  I've learned to live with the onscreen keyboard and so have millions of others, but for those who do it's because they're essentially all media consumers on their devices -- that is, they read a lot but send very, very little.

Is the corporate user a "mostly media consumer"?  Well, no.  They need a way to expeditiously do both from their handheld device, and this is where Blackberry still wins, and wins big.

The bottom line is this: The iPhone and Android are both aimed in a different direction.  Both have had plenty of time to aim at this issue for several years now and neither has.  Both have taken the position that the "rich media" paradigm wins -- and it does in the personal user space.  But for the corporate guy I'd argue that the rich media space remains a secondary thing -- the reason they have a handheld device in the main is to be able communicate, not consume. 

So what of RIMM the stock?  Well, the question here is rather simple: Is the company going out of business?  It all comes down to that.  If the company starts burning through its free cash flow and available cash then it will eventually run and die.  But there's no indication that this is happening; free cash from operations is being generated, EPS is positive and the firm expects to ship 11-12 million Blackberry phones next quarter.  In addition RIMM knows exactly how many actual subscribers it has since all devices communicate with them (something that has bit them several times with outages); active device count is up 35% year-over-year while the stock has declined by 75%!

Now clearly the stock was massively overvalued when it was $80/share.  But at under $15, unless they go out of business, it's an entirely-different proposition.  The company has no debt, it is generating free cash from operations, it's selling for under book as a stock, has a PEG ratio well under 1.0  and yet everyone thinks the firm is going to zero and hates it.  I'll take the other side of that down here.

Now let's talk Sprint.  This is another hated firm.  But here we have a company that's making losses.  It's primary factor that looks "good" is the spectrum it holds.  The issue here is the debt outstanding ($18.5 billion) .vs. the operating revenue ($33 billion) and the fact that despite $11/share in revenue there's no profit!

Here the question is entirely different: Can management turn losses into profits?  If the answer is "Yes" then at under $2.50/ticket this lottery play is damn cheap.  But if it's not then the enterprise value will slowly dwindle to zero and eventually either a covenant breach or simply running out of free cash will bankrupt them.  The vise is tighter here, but the cost of the lottery ticket is cheaper.  They have a huge customer base but never really recovered from the disaster of buying Nextel. 

The paradox with Sprint is the T-Mobile/AT&T merger.  That looks dead, to be frank.  Conventional wisdom is that this merger would trash Sprint.  I don't see it that way; I think the break, which now looks inevitable, might be an entirely different thing though.  AT&T will have to fork up some cash on the break and T-Mobile has materially improved its network during the pendency of the merger, which I did not expect to happen -- at all.  The conspiracy-minded among you might surmise from this that T-Mobile expected the possible failure of the deal and intends to try to capitalize on it if and when it happens.  I won't go that far but this much is pretty clear: The network has improved and yet from a standpoint of hurting Sprint it's not T-Mobile that's the threat, it's AT&T and Verizon.  So the break of the merger, if it occurs, would in my view help rather than hurt Sprint's prospects.

Nonetheless I still think Sprint has to "break the glass" in order to win.  I see no evidence that management understands this.  That makes getting involved in the stock very dangerous but then again $2.50 call options on management success with a company that has a rather-entrenched customer base aren't very common in the investing world.

All of this has to be overlaid with my general macro environmental view of the world: Leverage is coming out of the system.  I expect this to continue in 2012 and in fact to accelerate.  That's a much bigger risk for Sprint, as they have a debt issue to worry about.  RIMM does not.

Short form: I like the lottery play on Sprint, and if you think RIMM is going to survive it's worth a punt as well.  Neither should be plays you put money into that you can't afford to lose, because you might.  Of the two I think Sprint has the better upside potential in percentage terms (more than a double is entirely within the realm of reason and a 300% or more move is possible) but they have to stop making losses; if they don't they'll eventually blow up and leverage in a deflationary environment, which we're in and is going to get stronger over the next several years, makes this tougher than it would otherwise be.

As for RIMM everyone is focusing the takeout potential.  I can't ignore it -- that someone might come in and bid around $20 for the company is certainly there.  I've seen various patent portfolio numbers but I don't know how they're derived and that, in my view, is a raw guess.  In the longer term if the company can continue to post free cash from operations and increase their customer base as they have been despite all the screaming that they're imminently going to die, and the QNX handsets do show up (they pushed the date last night, which is not good) then you IMHO have a double.  In the shorter-term the issue is simpler: people hate the company and the stock and they're both selling and shorting it despite the fact that the firm is profitable and has no debt on the books.

Of the two Sprint has the better upside potential over the next 18-24 months but also the greater risk of a complete wipeout.  RIMM has less potential but less risk of being zeroed.  Both look like they're worth a play here with good money management and again -- only with money you're willing to lose.  RIMM requires monitoring if you're going to play there and a "quick-hit" mentality -- with Sprint I see it as more of a LEAP CALL with no expiration date other than management stupidity, which could zero you at any point in time.

Disclosure: Yes, I am doing both -- but I reserve the right to change my mind.  RIMM, in particular, worked in the past provided you didn't stick around too long and both money management along with paying attention is important.