September 26, 2008 / 5:12 PM / 10 years ago

ANALYSIS-RIM willing to pay for growth with lower profits

(In U.S. dollars unless noted)

By Wojtek Dabrowski

TORONTO, Sept 26 (Reuters) - Lower margins and profits may be the painful but necessary price that Research In Motion RIM.TO RIMM.O has to pay to capture a bigger market share with new models of its BlackBerry smartphones.

RIM shares fell about 25 percent on Friday to their lowest level in more than a year, a day after it warned that the costs of launching third-generation handsets like the high-end BlackBerry Bold would eat into its gross margins.

The components needed for the latest smartphones are expensive, RIM said, but that spending is necessary if the company is to continue growing its market aggressively.

“It is understandable that margins are going to be pressured when you are introducing several new products with more expensive components,” said First Analysis Securities Corp analyst Scott Pope. “Of course, this is essentially a requirement given the increased competition in the smartphone industry.”

RIM has held its own despite competitive threats from Apple’s (AAPL.O) popular iPhone and other handsets from the likes of Motorola MOT.N and Nokia (NOK.N). One of the reasons for its success has been the sturdy, reliable and increasingly fashionable design, both on the outside and inside the BlackBerry.

But such competition — particularly against the iPhone in the consumer market — can be costly. And to continue its torrid pace of growth, RIM has to make its increasingly feature-rich handsets attractively priced.

That, in turn, means the Waterloo, Ontario-based company is limited in its ability to pass along higher component costs to its customers.

“Without the ability to pass on the cost to your customers, they’re willing to eat it to get it back in the form of higher volumes,” said Research Capital Corp analyst Nick Agostino.

Part of RIM’s answer to the cost challenge will rest in eventually squeezing suppliers on component prices.

While this may be expensive at first, RIM appears confident the move will pay off. For the current quarter, it expects to add 2.9 million subscribers, which would push its total well over 20 million. It also expects revenue of $2.95 billion to $3.1 billion — higher than analysts expected, according to Reuters Estimates.

Still, the market is now focusing on the company’s gross margin, which plays a key role in determining RIM’s worth.

“It’s ridiculous, but that swing in gross margin is enormously important in terms of driving the share price,” said Duncan Stewart, president of Duncan Stewart Asset Management.

He said if RIM’s margin recovers in the next quarter or so to levels more palatable to investors and analysts, the shares could rocket back to $140 on Nasdaq.

If the margin pressure continues, however, the stock will likely continue to languish below $100, he said. It was at $71.99, down 26 percent, on Nasdaq, and down a similar amount on the Toronto Stock Exchange at C$74.18.


Some analysts have long held concerns that some of RIM’s large corporate clients could scale back BlackBerry purchases and upgrades as the economic downturn takes hold. The recent turbulence on Wall Street has underscored those worries.

However, RIM’s guidance for revenue and subscriber additions reassured observers that the economic impact right now is limited.

“We need more evidence of failure to sell devices before we start saying it’s a weak economy or it’s people being laid off from Lehman Brothers,” Stewart said.

Agostino and Pope also cited anecdotal evidence that laid off workers in the financial sector end up buying personal BlackBerrys anyway.

“If the enterprise side of the business is having an impact, then they’re certainly able to absorb it by going after the consumer,” Agostino said.

The term “enterprise” refers to RIM’s large corporate and government clients.

However, Agostino added that if the financial crisis spills over from Wall Street to Main Street, consumer buying patterns could change.

That might mean RIM’s rapidly growing base of retail consumers decides to hold off BlackBerry purchases.

That, Agostino said, is “the bigger question mark.”

$1=$1.03 Canadian Reporting by Wojtek Dabrowski; editing by Rob Wilson

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