Research In Motion Analysis

July 2, 2007 by Joe Ponzio

You can’t argue Jim Cramer’s past success. The guy is a stock picking/gambling guru and he’s hot on Research In Motion (ticker: RIMM). So much so, in fact, that he told his viewing public to buy it after Thursday night’s earnings report. Why not? The stock ran up some 20% on Friday following giant earnings.
Let’s take a look at RIMM’s business to see if it is a wonderful company to own…or just a hot stock for now.

Wall Street is hyped up because RIMM’s first quarter earnings were up 73% from a year ago, on 77% higher sales. Know what that means? The company reported $223.2 million of earnings for its tax return. That means that this Canadian Blackberry maker will be cutting Canada’s Uncle Sam a fat check this year-so far at least.

Earnings Won’t Pay The Bills

High earnings are nice-but they don’t pay the bills. Research In Motion’s vendors and creditors won’t take earnings as a form of payment. Like you, I, and all other companies, RIMM has to pay cash for the goods and services it buys or it will run into problems, supplies and services will slow down or stop, it will be forced to stop selling as much, and the tax-return-based earnings will dry up.

A Look At RIMM’s Cash

If RIMM can’t convert its sales into cash in the bank, it can’t grow, sustain operations, expand into new markets, or acquire other companies. No company can survive or sustain high earnings for long if it can’t generate or otherwise acquire cash.

From 1998 through 2006, RIMM has had a total negative free cash flow of $40.5 million. On average, RIMM is burning through $4.5 million of cash a year, after all expenses are paid, supplies are purchased, etc. In essence, if RIMM had to rely on its operations alone (without being able to borrow money or sell stock), it would have to rely on its sales to cover a chunk of expenses…and then use its cash and sell assets to cover the rest.

How It Has Made Up The Difference

From ’98 to ’06, the company has raised $1.5 billion in cash through a combination of selling stock, issuing bonds, and a few other financing deals. Surely it has been trying to use that cash to fuel growth and the company has done a good job of increasing sales during that time, but it doesn’t change the fact that RIMM has been burning through cash.

Here’s The Problem (For Any Business)

To help pay its bills, RIMM appears to be relying on its ability to sell stock and borrow money-mostly selling stock, to the tune of $1.9 billion from 1998 through 2006. If it can’t generate enough cash to keep things going, it has to rely on these outside sources of cash to cover its expenses.

Aren’t Expenses Included In Earnings?

No. Remember-earnings and expenses are accrued which means they are what the company reports to the government, regardless of when the cash actually comes into or goes out of the bank account.

Is RIMM In Trouble?

Not yet. The company may have finally broken through the invisible sales barrier that was forcing it to burn through cash. After all, sales are at an all time high and may finally be at the level where RIMM can begin generating more cash that it spends-from its operations.

If RIMM can’t convert its sales into cash, then it is in trouble. A company can only sell so much stock and borrow so much money before its financing resources are tapped out. Once RIMM hits that point, if it can’t convert sales into positive cash to sustain or grow operations, its only option will be to shrink until its operations find a balance that will produce positive cash flow.

Mind you, this is not my opinion-it is the basics of running a business.

To Buy or Not To Buy?

I’ll tell you flat out-I’m not going near RIMM at this point. I like to buy wonderful businesses that can prove that they can grow on the merit of their operations alone. RIMM hasn’t done that yet. Think about this: How long could you survive if you didn’t generate enough cash to pay your bills and had to borrow (or charge) to make up the difference?

Am I missing out on an opportunity to make a lot of money? Maybe. If this is, in fact, the turning point for RIMM and it can begin growing based solely on the performance of its operations, then I am missing out.

But I don’t like to gamble in stocks. I don’t like to worry if my business is going to grow or not. I don’t like to play around with my future. I’ll pass on Research In Motion for now, give it ten years or so to prove that it is a wonderful business, and continue my search for another Johnson & Johnson.

My Disclaimer On RIMM

I recently purchased a Blackberry and I love it-I think. I’m still getting used to it, but the company seems to make good products. Unfortunately, good products won’t pay the bills in my retirement-good companies will.

A Note From Joe Ponzio

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