Blessed by the Potato

Nothing’s really been jumping out at me in the stock market lately, but RIM and Cisco keep coming into my consciousness as things to look at. Largely because there’s been much wringing of hands and concern that these stocks might be toast, which is sentiment that usually gets my attention, and partly because they’re mentioned in the news and it sticks in my brain.

I did a very quick look at Cisco back in December when it was in the $19-$20 range, and after spending just a few minutes on it, I decided that it wasn’t cheap enough, and made a note to look more deeply at $17. Well, now it’s fallen below $17, so I suppose it’s worth taking a deeper look. Since then the stock price has fallen, and they’ve instated a dividend to finally put the excess cash to use. But the projections for earnings have been flattening out, and while it looks fairly valued to me at this point, I’m not keen enough on it to settle for fair, and will wait to see if it’ll come at a discount later.

RIM has been all over the place the last few years. I have a BlackBerry myself, and though I was not a heavy cell phone user before (a few minutes/month of talk time, and I never did figure out the allure of texting on a numeric keypad), I find that I do use BBM and the web capabilities fairly regularly. I see my mom, who can’t really figure out the mouse on the laptop we got her for xmas, using her BlackBerry to email people, check the weather, and share pictures. It made me a real believer in continued growth of the smartphone sector. Though RIM’s share of the smartphone pie is undoubtedly shrinking as Apple becomes a cult and Android picks up steam, it is still a growing pie on the whole, and the net result is that RIM has still been growing. Yet despite that, they’re trading at only about a P/E of 8, and with a clean balance sheet.

In the medium term, I find it hard to see how their earnings start to shrink rather than grow. Even if they just stay flat from here, that’s a decent valuation. There’s some noise about the PlayBook sucking as it’s released now, but I don’t really care: it’s gravy if it works, and it shouldn’t hurt them as a business if it flops, as long as BB smartphones keep rolling off the lines. One of the big complaints seems to be the size: why go for 7″ when the iPad is 10? I’m not a tablet user, but that seems weird to me: at 10″, why not just go for a netbook and get a keyboard? 7″ seems more appropriate for a portable tablet.

Long-term though, I have worries. As smartphones become commodities, will their profits drop? Will RIM become just another entry in the tech stock history book? Their moat is pretty thin: BBM has a nice network effect, especially in regimes with high per-text-message costs (which BBM sidesteps), and they have a strong reputation for security (which is apparently counting for little as more and more corporations allow iPhone/Android handsets to access their email servers, and foreign governments try to get access to the servers, etc.).

My dad says it’s a broken stock — the company may be fine, but so many (US) analysts are against it that you just can’t touch the stock. Even on good news it goes nowhere. That advice has wisely helped keep me out of RIM when it looked cheap at 10X P/E and 9X P/E… but at some point I’ve got to say come on, how cheap does it have to get? However, I’m still not sure that it’s cheap enough now to take the risk.

Though these names may be coming to mind, that doesn’t mean I have to buy in: there are lots of ways to make money. Even if RIM looks quite undervalued now, if I’m not assured of their long-term (beyond the next 5-years) success, then I can just let the opportunity pass. There will be others — hopefully ones I can understand and project better.

One that just cropped up as a tech company is Indigo Books & Music. Not really a tech company: the Chapters/Indigo/Coles bookstores are the dominant bricks & mortar stores in Canada. They also have the chapters.indigo.ca web store, but physical store revenues dwarf online. And oddly enough, physical store earnings have been growing, while online shrinking the last few years.

What makes them a tech company (at least for the purposes of this post) is that they have a majority ownership of Kobo e-reader (which is both a device, very similar to the Amazon kindle, and also a software reader for the blackberry, ipad, playbook, and other devices). This is the part that’s really getting me interested: the Amazon kindle is the leader of course, but with a few exceptions (unlocked books) you can only buy books for the kindle from Amazon, and can’t move your library from device-to-device. Most books you buy from Amazon for the kindle are locked to it forever. The Kobo is supporting not only Chapters/Indigo but other booksellers as well, including the public libraries (in several countries). AFAIK, you can take your library with you to other platforms (with a software Kobo reader). Indeed, I’ve heard that if you have a Kobo reader and the Kobo smartphone application, it will track your last page read between them, so not only can you copy your library to multiple platforms, you can read on multiple platforms without losing your place (catch a chapter on the subway on your blackberry, then automatically pick up where you left off on the Kobo at home).

Kobo just had a stock issue, diluting Indigo from 58% ownership to 51%. If I’ve done my math right, that values Kobo at over $220M, or about $110M to Indigo, which from what I can see of their balance sheet is “hidden value” — the notes suggest that it’s carried as an asset at only about $4M.

Earnings haven’t been fantastic: they don’t break it down in the quarterly statement, but in the last annual report it was the bricks & mortar stores that had all the growth, and online actually shrank a bit. Should be ~$0.90/sh this year, and I’m assuming that stays fairly stable. That’s a big assumption: the looming threat, the big question is whether Amazon can threaten their bricks & mortar business, and if it hasn’t happened yet (SSSG was positive), they may be fairly safe (though that’s in part because they’ve been moving from just being a bookseller to selling stuff like wrapping paper, gifts, etc). Gift cards are surprisingly profitable for them, and may be a large part of what’s keeping the bricks & mortar business afloat (indeed, basically all their profit seems to come from the x-mas quarter, and the rest of the year is just break-even).

The balance sheet is good: Tangible Book Value (assuming inventory is worth 100%; current assets-total liabilities) of $4.25/share, total stated book value of $11. But, if Kobo is worth another ~$4/share and isn’t recorded in there (total goodwill is only $1/share), then that could make the balance sheet even stronger, and that’s my main source of interest here. As I write this, IDG is $13, so a slight discount to book value in that case, and if Kobo keeps growing as a company in its own right, it might be worth more than IDG in the not-too-distant-future.

The risks: one word sums it up: Amazon. Bookselling is a low-margin business, and they are still essentially a bricks and mortar company, while the world has been moving towards internet-based shopping (either for physical delivery or ebook readers). That does speak poorly that they haven’t managed to take the chapters/indigo brand and turn it into a strong electronic store as well. Another negative point is that there’s been a large amount of insider selling (both President and CFO), over $4M in the last year.

No position in RIM or CSCO, just bought a small position in IDG today.