RIM: A torch in the darkness

The new BlackBerry Torch is a big step forward, but analysts doubt that it will be enough to reverse the fortunes of RIM's sliding stock.

All year, analysts, techies and fanboys speculated Research In Motion would release a new BlackBerry to fend off competitors and establish a greater foothold in the consumer smartphone market. Tuesday, Aug. 3 appeared to be that day, as media gathered in New York City after receiving cryptic invitations from RIM and its carrier partner, AT&T. RIM co-CEO Mike Lazaridis finally ended the speculation and unveiled the new device: the BlackBerry Torch.

The company’s share price had been ticking up for days in anticipation of the launch and continued to do so as Lazaridis and other execs touted the Torch, which features a touch screen as well as a physical keyboard. But as the execs left the stage and the guests were released to try the Torch for themselves, RIM’s stock dropped 4% over the next 40 minutes, and fell further during the next couple of days.

The markets are underwhelmed, and there are other issues for RIM investors to worry about as well. Governments in Saudi Arabia and the United Arab Emirates have threatened to shut off all BlackBerry functions aside from voice unless they have more access to user data, and a handful of other nations recently expressed similar security concerns. There is also the nagging fear that, even with its new-and-improved BlackBerry operating system, RIM still lags behind Apple’s iPhone and the Google Android platform.

RIM investors can be forgiven for not knowing what to think about the company’s future. Since late September, RIM shares have fallen 43% even as the company snags millions of new subscribers and posts healthy profits. Analysts are widely divided. At the pessimistic end of the spectrum, some have RIM’s stock languishing around $50 for the next year, predicting RIM will struggle to compete with Apple and Android in offering consumers a range of applications and a rich multimedia experience. The optimists contend RIM stock will shoot back over $100 (it’s around $53 now) and could be tremendously undervalued. RIM is trading at roughly 11 times earnings, its lowest level in five years. When the Torch goes on sale this month, it could either reverse or hasten RIM’s share-price decline.

Media coverage surrounding the launch presented the Torch as RIM’s attack on the competition, an attempt to win over new smartphone users and draw some away from the iPhone and Android phones. But the Torch is not so much an offensive strike as a defensive measure. RIM has reason to worry about keeping its customers. Although the company is still gaining share worldwide in terms of the overall mobile handset market, it is losing ground to Apple and Android in the smartphone market. A survey conducted by the Nielsen Co. in July found only 42% of existing BlackBerry users planned to purchase another one. The rest said they would switch to a rival platform. “The Torch is making sure a lot of the core business users don’t migrate to iPhone or Android because of touch,” says Carolina Milanesi, a research vice-president for mobile devices at Gartner Inc. in the U.K. RIM’s first touch screen attempt, the Storm in 2008, was not well received. The Torch is a hybrid that will not alienate traditional BlackBerry users, providing the familiarity of a keyboard while allowing them to indulge in a touch screen.

The Torch also packs a new operating system and web browser — areas in which BlackBerry devices appeared woefully behind. Early reviews of the Torch suggest RIM greatly improved both features, and the most favourable reviewers venture the company’s software is as good as what competitors offer. “This is the best BlackBerry ever released,” wrote Gus Papageorgiou, managing director of technology research at Scotia Capital, in a recent note. “The BlackBerry torch will be a strong seller worldwide.” What’s more, RIM will roll out the updated software on a number of new devices over the next few months, giving existing users a compelling reason to upgrade.

But while the Torch may be RIM’s best offering to date, it needs to be better than the competition to win new converts. “I don’t think you’ll see iPhone users now going to RIM because of the Torch,” Milanesi contends. Part of the reason is that BlackBerry users still have fewer applications available for their devices. There are roughly 200,000 available for iPhone, and Android users have more than 30,000 to choose from, whereas there are fewer than 8,000 available for the BlackBerry. “What we’re looking for from RIM is what their incentives are to get software developers to focus on the RIM platform,” says Jeff Fidacaro, an analyst with Susquehanna Financial Group in New York, who has a neutral rating on the stock.

Coding for the BlackBerry platform is generally more difficult and time consuming for developers because there are many different models with varying features and screen sizes. There is also less developer support, according to Peter Sisson, whose California-based company, Toktumi, created an app called Line2 that adds a second line to phones. The iPhone version took weeks while the BlackBerry version took months. The new operating system is an improvement in terms of support, he says, “but it’s just a baby step.”

This could spell disaster for RIM down the road. Consumers want apps, Sisson contends, and developers will follow consumers. “We’ll go where the money is,” he says. As of now, that doesn’t include BlackBerry.

That worry is why Ian Ainsworth, a senior vice-president at Mackenzie Investments in Toronto, gradually sold all of the RIM shares in the funds he manages. “Even though RIM has a great product, that threat started to concern us,” Ainsworth says. But the recent drop in valuation and the new operating system are prompting a second look. “This is the beginning of the race for RIM in some ways,” he says, adding he’s waiting to see how developers respond.

There are other reasons to watch RIM. The attention on applications and touchscreens ignores the fact that many users prefer a text-based device. Teenagers and college students have flocked to the BlackBerry because of its instant-messenger service, and the BlackBerry is an increasingly strong brand internationally. Apple sells its iPhone in fewer than 100 countries, while the BlackBerry is in 175.

The iPhone is an expensive device and roughly 80% of the world does not provide subsidies, unlike North America and parts of Europe. This puts the iPhone and many Android devices out of reach for consumers in developing countries. Not the BlackBerry. RIM is adept at tailoring devices for different markets, and the Curve series has been an international hit precisely because it is relatively cheap. Carriers in developing countries spurred sales by offering inexpensive unlimited texting plans, and RIM, which runs data through its servers partly to compress data, allows users to maximize their data usage at a low cost. RIM now generates 37% of its revenue outside of North America.

“If you are a smartphone company and you want to be successful over the next few years, you have to be able to produce smartphones with good capabilities that cost less than $100 to manufacture,” says Pablo Perez-Fernandez, a senior wireless analyst at MKM Partners in California. “RIM understands this.” Investors, however, are fixated on the U.S. market and gloss over RIM’s international presence, he argues.

Ironically, investors and analysts who have followed RIM’s success abroad are concerned about it. Because the Curve is inexpensive, its popularity has been pulling down the average selling price (ASP) of the BlackBerry in RIM’s financial statements. Some analysts are concerned that a lower ASP will also drag down RIM’s impressive gross margins. This, too, has depressed the stock.

But in fact the opposite has happened. Dushan Batrovic, an analyst at Dundee Securities Corp. in Toronto, pointed out in a recent report that while the ASP has fallen from $349 to $300 over the past six quarters, RIM’s gross margins have actually increased, an indication that the company is carefully managing costs. “We don’t believe it’s a stretch to call RIM one of the most unpopular stocks in large cap tech,” Batrovic wrote. “If RIM can grow at roughly half the industry growth rate, investors will make money.”

But the brewing controversy over security could threaten RIM’s growth prospects in the developing world. RIM protects user data through ultra-hard encryption, which has always been a primary selling point, and a number of governments are demanding more access for monitoring purposes. The company reached an agreement with Saudi Arabia recently (details were not available as of press time) that could provide a framework for use in other countries, including the UAE. Even if an agreement cannot be reached in the UAE, the country is relatively tiny market for RIM. More worrying are similar questions about security coming from India, a nation of more than one billion people. RIM has also spent time laying the groundwork for an extensive rollout in China, a massive market, but one in which censorship and Internet monitoring is standard practice.

Unfortunately for RIM, the uncertainty will persist for a while. “It’s very difficult to predict what governments are going to decide,” Perez-Fernandez says. But RIM investors are used to uncertainty — or at least they had better get used to it. The Torch may have narrowed the gap between RIM and its competitors, and international growth looks promising, but the smartphone market is still anyone’s to take.