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Scott Barlow is optimistic about BB10 sales, but Sean Silcoff is concerned with falling service revenues that deliver profits.

Scott Barlow is optimistic about BB10 sales

Both the positive and negative views for Research in Motion sound equally compelling to investors. That's decidedly unhelpful. Though I have my reservations, I side with the optimists – and for reasons that few have considered.

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Credit Suisse analyst Kulbinder Garcha has a well-articulated bearish case for RIM. His brutal assessment puts the total value of the company at $3.1-billion (U.S.), 70 per cent below its current valuation by the market. Mr. Garcha is particularly concerned about signals from management that the new BlackBerry 10 device will come with a premium price close to $400 per handset, a level where he believes lacklustre interest will keep RIM's share of the smartphone market close to 3 per cent.

The bullish outlook for RIM is more popular, although to a cynical eye, it appears that analyst optimism is chasing the stock upwards. Nonetheless, Scotia Capital Inc. analyst Gus Papageorgiou's $23 target appears well grounded. Mr. Papageorgiou believes that significant pent-up demand will push BB10 sales to 29 million in the current fiscal year, contributing $4.13 a share to profits. He expects that 71 per cent of business users and 21 per cent of consumer clients will upgrade to the new smartphone.

Before the BB10 is released and pricing made official we can only speculate on its potential success – and RIM's. Scotia's 71-per-cent upgrade projection for business users seems both plausible and important. Corporate IT departments that are already using RIM handsets are reluctant to provide support for non-Blackberry devices. The BB10, if at all attractive, will lessen the pressure on these IT departments to offer alternatives.

The slow tarnishing of the Apple Inc. brand is another factor supporting a bullish outlook for Research in Motion. Apple has hit a lull in its product cycle, with no revolutionary products released in the past few quarters. The novelty of the iPhone is waning along with the company's stock price, providing RIM with a market opportunity.

Sean Silcoff is concerned with falling service revenues

Every twitch and turn in Research in Motion's stock reflects the latest analyst opinion on the BlackBerry 10 question. But another is extremely pertinent: the future of its service revenues.

For years, service charges have represented a dull but dependable portion of RIM's revenues. RIM earns handsome returns by charging server fees, licensing fees and carrier fees for every device in use. As RIM's hardware sales collapsed – dropping to $1.6-billion in the third quarter from $4.1-billion in the same period a year earlier, RIM's service revenue actually grew by 1 per cent, coming in at $974-million and representing 36 per cent of revenue. The company doesn't break out profit contributions but, based on market intelligence, it's evident that the handset business lost money, while the services business scored a huge operating profit.

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But now RIM will no longer charge across-the-board service fees, instead offering an à la carte choice. Enterprise customers who need advanced security, management of multiple devices and other services will be upsold an enhanced offering – including software that allows them to manage an array of phones, even those of its competitors – while consumers and other smaller customers will be charged little or no service fees.

"Service revenues are not going away, but our business model and service offerings are going to evolve" – and service fees will be "under pressure over the next year during this transition," CEO Thorsten Heins told analysts on a conference call last month.

It's a big risk and further clouds the picture for forecasters, adding more volatility to RIM's outlook. As the Globe's Iain Marlow points out, RIM will be relying even more on hardware revenue at a time when hardware profit margins are falling across the industry.

But it's a fair gamble by a CEO who has no choice but to stake the company on the BB10, and one more example that the Waterloo, Ont.-based company is much humbler and more attuned to the market than it used to be. Changing up service fees is an acknowledgment by RIM that its customers will not continue to merrily pay high fees for the privilege of using BlackBerrys: the market is too competitive, and RIM has permanently lost leverage as the iPhone and Samsung's Android phones have taken over the business.

RIM's fee schedule has to be flexible and based on the demands of customers with an array of choices; holding the line would have added a competitive disadvantage to the BB10 and could have ultimately hurt service fees down the line anyway. It means, however, that if BB10 is a bust, they won't even have service revenue to fall back on, and the stock could be worth even less than its lows of last fall.

Investors can only hope that Mr. Heins is right – that if he builds a popular device, the service revenue will come.

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About the Authors
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More

Sean Silcoff joined The Globe and Mail in January, 2012, following an 18-year-career in journalism and communications. He previously worked as a columnist and Montreal correspondent for the National Post and as a staff writer at Canadian Business Magazine, where he was project co-ordinator of the magazine's inaugural Rich 100 list. More


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