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Mathew Ingram

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Roll out the RIM

Mathew Ingram

 TORONTO — Shares of Research In Motion climbed by more than 15 per cent last month, after the company announced that it had settled a long-standing patent infringement lawsuit with U.S.-based NTP Inc., and investors applauded the end of the uncertainty that had surrounded the handheld maker for more than two years. And who can blame them? After all, at one point not that long ago, RIM looked as though it might get hit with an injunction preventing the company from selling its popular BlackBerry devices in the United States, its biggest market. Now that threat is gone, and the patent lawsuit is just a memory. Why not celebrate?

If you enjoy following the crowd, then by all means join the celebration, along with the others who have pushed RIM's stock up by more than 25 per cent in just the past three months, to a recent close of $76.45 (U.S.). If you enjoy a good contrarian bet, however — and have an appetite for more than the usual amount of risk — you might want to head in the other direction. In other words, sell while everyone around you is buying: that is, sell RIM's shares short. There are more headwinds facing Canada's favourite handheld maker than there are tailwinds, and yet the market still seems to be convinced that the company's stock is headed higher.

It's true that RIM has fallen back from its high in March of almost $90, but it is still almost 25 per cent higher than it was at the beginning of the year, and its valuation remains exceptionally optimistic. Its trailing price-to-earnings ratio (based on the last 12-month period) is over 40, and its P/E based on profit estimates for this year is 25. That means you are paying $25 for every $1 of profit. RIM is also trading at more than seven times its revenue per share, compared with just 1.5 times for Palm Inc. RIM's price-to-sales ratio is just a little shy of Yahoo's, and yet the much larger search company's profit margin is 35 per cent, while RIM's is only 18 per cent. Palm's profit margin is 21 per cent, and yet its valuation is much lower.

What has pushed RIM back from its recent peak is concern about its revenue and subscriber growth, and that is also the core of the short-seller's case. In its latest update, the company said it expects to have sales of $580-million to $610-million in the current quarter, with earnings of 60 to 65 cents per share. That's sharply lower than the profit of 76 cents a share most analysts were expecting, on sales of $620-million. And while many analysts were looking for the handheld maker to add a total of more than 725,000 subscribers, RIM said it would likely add just 675,000.

Is this just a short-term delay in returning to the growth rates the company saw before it got wrapped up in the patent case? That's what much of the market seems to think. But what if it isn't? The reality is that RIM's revenue growth rate has been declining for the past eight quarters in a row, and its subscriber growth rate has been doing pretty much the same thing. It would be nice to think that RIM could reverse that trend, but it might not be that simple. More than one analyst believes that the company's growth will continue to slow, as competitors build on the inroads they made while the court case was going on.

At this point, RIM's biggest problem is that it is the market leader, and that is a very difficult position to maintain. In fact, the company has been able to build such a lead in part because its competitors have been unfocused and in some cases incompetent. What are the odds that state of affairs will continue? Slim at best. Microsoft often fails in its first few attempts to dominate a market but it rarely fails altogether, and it has its sights set squarely on RIM's leadership position — and it now has a partnership with Palm to boot. Nokia is also in hot pursuit, and has a position in the cellular handset market that rivals RIM's share of the handheld market.

If you were to make a skeptical bet on RIM, you wouldn't be alone. Several analysts have become bearish on the company's prospects, including Andy Neff of Bear Stearns, who recently reduced it to "underperform" from "peer perform." Michael Ounjian of Credit Suisse First Boston has said that while he expects subscriber growth to continue, he believes that the company's business model will "come under pressure as increasingly attractive alternatives become more widely available." Rochdale Securities, which rates the stock a "sell," says that its intrinsic value is $45 a share. That's a long way away from $75 — about 40 per cent, in fact.

So where's the risk? The risk is that there is a lot of optimism out there surrounding RIM — more optimism than is probably warranted, given the company's situation. Obviously, that's what you're trying to take advantage of with a short sale. The problem is that a heavily-traded retail stock such as RIM can see its share price spike upwards by as much as $15 or $20 in a single day on a piece of good news. That can crush a short position in an instant if it puts you over your limit and the bank or brokerage firm calls you to settle up. That can be expensive — and it can happen more than once in a trading period, depending on the firm.

If you're right and RIM's future is one of slower growth in sales and profits, then eventually the market will arrive at that viewpoint as well and the stock will fall. But it's not going to get there all at once — and you could find yourself under a substantial amount of pressure in the interim. And that's why short-selling isn't for the faint of heart.

Mathew Ingram joined The Globe and Mail's online news team in June of 2000, after spending four years as the Western business columnist, based in Calgary.

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