Telecommunications

RIM Tempers Earnings Forecast


Shares in wireless phone provider Research In Motion plunged on Feb. 11 after the company said it will report fourth-quarter earnings at the low end of previously announced expectations.

The news came with an update on subscriber additions, which RIM (RIMM) said will come in at 3.5 million, or 20% higher than the 2.9 million the company said it had expected on Dec. 18.

Battling Apple for Customers

Investors interpreted the announcements as further evidence that Waterloo (Ont.)-based RIM, maker of the BlackBerry line of wireless devices, is sacrificing its profit margins in a bid to win customers. RIM is engaged in a pitched battle with Apple (AAPL), maker of the iPhone, for dominance of the hot market for smartphones.

In December, RIM projected fourth-quarter profit of 83¢ to 91¢ a share, and analysts forecast an average EPS of 85¢. On Feb. 11 the company said it expects earnings to be "at or near the midpoint of the previously guided range," for the quarter ending Feb. 28. RIM shares dropped sharply in pre-market trading and had dropped 9.50, or nearly 17%, to 47.54 by 12:45 p.m. ET in trading on the Nasdaq. The stock has lost more than two-thirds of its value since peaking at 148.13 in mid-June.

RIM also said gross margins, a measure of profitability, will be at the low end of prior projections of 40% to 41%, down from 45.6% in the third quarter. The company cited several reasons, including an increase in the ratio of new subscribers versus subscribers who are upgrading to new devices.

New Curve Could Be Hard Sell

As part of its drive to attract users, RIM also introduced an update of its popular Curve device, the Curve 8900. The new handset, sold through T-Mobile, boasts an improved screen over the prior Curve model and a revamped user interface.

James Faucette, an analyst at Pacific Crest Securities in Portland, Ore., says a lot is riding on the new device. "RIM is hitting an air pocket," he says. "If the 8900 is successful at T-Mobile, then RIM will be in good shape, but I think RIM is going to have a tough time differentiating the product from other phones on the market."

The company has in recent months launched a handful of high-profile products, including the BlackBerry Bold, a 3G handset with wireless carrier AT&T (T), and the Storm, a highly anticipated but much criticized touchscreen device carried by Verizon Wireless, owned by Verizon Communications (VZ) and Vodafone Group (VOD). RIM also launched its first flip-phone device with Deutsche Telekom's (DT) T-Mobile last year.

Cool New Phones Aren't Cheap to Make

Faucette says much of the pressure on margins is coming on the hardware. Since the Bold and Storm are more expensive for RIM to make, they carry lower gross hardware margins than other BlackBerry devices. Faucette says hardware margin tends to run in the 40% range, but are thought to be in the low 30s with these two devices. Faucette rates the stock as "sector perform," with no price target. RIM doesn't break out its gross margins by product.

Last month an estimate by market research firm iSuppli pegged the Storm's hardware cost at slightly less than $203, while it sells at Verizon for $199 with a two-year contract. Another iSuppli teardown, of the Blackberry Bold, yielded a hardware cost estimate of $158.

Analyst Maynard Um at UBS (UBS) wrote in a research note that a survey showed customer returns of the Storm tended to lead to sales of the cheaper but more profitable Curve, providing some help to margins but at the cost of average selling prices. There are "new questions as to whether there is pricing pressure impacting gross margins, where the bottom on gross margins are, and the outlook for hardware end demand," writes Um, who rates the stock as "neutral," with a $57 price target.

Other analysts saw the sudden drop in the stock as a buying opportunity. Tavis McCourt of Morgan Keegan & Co. wrote in a research note that the company has set expectations that can be beat. "Commentary by RIM is remarkably similar to a guidance update for February of last year, and we expect this implies May will shape up to be another strong quarter for RIM," he wrote. He rates the stock an "outperform," but the firm does not issue target prices.

RIM will report earnings on Apr. 2.

Hesseldahl is a reporter for BusinessWeek.com.


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