RIM Fee Change Makes BlackBerry 10 Do or Die

NEW YORK ( TheStreet) - Research In Motion's ( RIMM) third quarter earnings were expected to be of secondary importance to management commentary and the company's forecasts headed into a pivotal quarter that will see the launch of the much-anticipated BlackBerry 10.

Still, Research In Motion was able to throw a big curveball to investors and analysts on Thursday after beating third quarter earnings forecasts.

The Waterloo, Ontario-based BlackBerry maker announced a change in the way it will charge users service fees, putting a putting a key source of revenue - that drove over 36% of the company's $2.7 billion in sales -- at risk. The announcement and a lack of specifics on how the change will impact earnings precipitated a 20% reversal in RIM's shares in after-hours trading.

Initial Thursday aftermarket share gains in excess of 10% now stand as 20%-plus losses in Friday afternoon trading.

Analysts reacted negatively to the policy change and raised new risks for the struggling mobile handset maker, as it tries to compete against Apple ( AAPL), GOOG ( GOOG) and Microsoft ( MSFT)-powered smartphone and tablet devices.

"RIMM reported better revenue and a smaller than expected operating loss amid low expectations. Its cash balance again grew through smart working capital management," wrote Sterne Agee analyst Shaw Wu, in reaction to RIM's earnings figures. Still, the numbers were overshadowed by the pricing strategy shift, which CEO Thorstein Heins unveiled on the company's earnings call.

" There were two negative surprises related to the pending launch of BB10 in late-January: (1) its favorable working capital trends will likely reverse due to higher expenses meaning cash usage and (2) its high-margin services business will likely see pressure as it transitions to new terms and pricing," wrote Wu, in a note to clients released on Friday.

"RIM will offer tiered services, with enterprises who only need basic email connectivity paying a lower monthly average revenue per user," wrote Jefferies analyst Peter Misek, in a Friday note to clients. While RIM will continue to charge businesses fees on services such as email security, Misek added, " Management would not comment on the consumer side, but we believe their statement refers to some BB10 consumer subscribers no longer generating service revenues."

Misek questioned whether the pricing change is a "Grand Bargain or Faustian Bargain," noting that the pricing change may make its relationship with carriers and businesses similar to more consumer-oriented competitors like Apple and Google, while it also could undercut a ballast to earnings.

"We believe RIM may have traded consumer monthly service fees (or a vast reduction in fees) in exchange for volume commitments and high average selling prices," wrote Misek. "Carrier support dramatically increases the chance of BB10's success (we estimate an increased chance of success from 10% to 30%), but now RIM is playing without a safety net," he added.

In third quarter earnings, RIM reported revenue of $2.7 billion and a net loss of 22 cents a share. That beat Wall Street expectations of $2.6 billion in revenue or an adjusted loss of 35 cents a share, according to analyst estimates compiled by Bloomberg.

Crucially, cash at the handset maker came in at $2.9 billion, an increase of $600 million in the quarter. Research In Motion also posted $950 million in cash from operations.

RIM sold fewer handsets than expected but saw stronger than expected gross margins of 30.4%. RIM shipped 6.9 million BlackBerry smartphones and roughly 255,000 BlackBerry PlayBook tablets, according to a press release. The company also saw its subscriber base shrink to 79 million users, its first ever user decline.

On a post-earnings analyst conference call, RIM CEO Heins highlighted how a better management of the company's purse strings will help with new product launches. "Working capital performance has been very strong... these resources will be reinvested in our BlackBerry 10 launch," said Heins, while adding that a $1 billion 2013 cost reduction program has already been achieved.

Although RIM is running ahead of expectations on its management of cash flow, the company's CFO warned that it will post an operating loss in the fiscal fourth quarter as a result of service fee declines, a cannibalization of potential BlackBerry 7 sales and a significant increase in advertising spending heading into the BlackBerry 10 launch. RIM nevertheless said it would end the year with significantly more than the $2.1 billion in cash that it entered the year with.

CEO Heins said a mix of improving cash flow, quicker than expected cost reductions and a strong response to BlackBerry 10 means the company is hitting a bottom heading into 2013 after years of market share losses. "We believe the company has stabilized and will continue to turn a corner in the New Year," said Heins on the analyst call.

Third quarter earnings give crucial insight into RIM's financial picture headed into the New Year, but they are unlikely to change the longer term outlook of the struggling handset maker. More importantly, analysts and investors await details on the launch of BlackBerry 10, and prospective enterprise and consumer demand.

That launch, slated for late January, may provide more insight than third quarter earnings on whether RIM can reignite competition against Apple ( AAPL) and Google ( GOOG)-powered devices in the ultracompetitive handset and tablet markets, or whether its best option resides in a takeover or asset sale.

That's the perspective of Donald Yacktman, the head of Yacktman Asset Management, a mutual fund investor that is Research In Motion's fifth largest shareholder, according to Securities and Exchange Commission filings compiled by Bloomberg.

In a telephone interview prior to RIM's earnings, Yacktman said he wasn't expecting much out of the company's third quarter earnings. "I wouldn't expect a lot. I think they are burning a lot of cash right now," Yacktman said.

From Yacktman's perspective, the fund's investment in RIM is about the handset maker's discounted price and a set of assets that include cash, patents and an large embedded user base that puts a floor on the company's share prices.

"If the phone works out great, in the future you have tremendous upside," said Yacktman of RIM's BlackBerry 10 launch. If not, Yacktman expects RIM to be acquired by a healthier competitor.

According to Bloomberg data as of Sept. 30, Yacktman Asset Management owns just under 4.5% of RIM's outstanding shares worth $325 million. Yacktman said in the telephone interview prior to earnings that the mutual fund was in the money on its RIM investment. Any changes to Yacktman's RIM position will be unveiled in mid-January, when the manager releases year-end holdings

Given RIM's pricing change ahead of BlackBerry 10, Yacktman's wait and see approach to third quarter earnings may become all the more relevant.

"If BB10 fails, it will likely be unable to stumble along and will either become a take- under candidate or a niche business," wrote Misek, the Jefferies analyst, of how the service fee changes potential outcomes of a RIM turnaround. "If BB10 succeeds, its business model will more closely resemble other handset manufacturers," added the analyst, referring to subsidized consumer-oriented smartphone makers like Apple and Google.

For more on Research In Motion's prospects, see the top 4 risks to BlackBerry 10. Also see TheStreet's initial review of the RIM's new line of handsets and its operating system.

-- Written by Antoine Gara in New York

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