RIMM: Their Products, Strategy & Management All Suck….Are They So Bad That It Could be Good For Your Portfolio?

by Dan August 19, 2011 10:49 am • Commentary

RIMM is up almost 5% this morning on continued take-over speculation in the financial press and the blogosphere.

By almost all accounts and metrics, GOOG‘s $12.5 billion all cash take-over offer for Motorola Mobility was a bit excessive. Many market watchers were left scratching their heads as to why GOOG needed to “buy the cow when they get the milk for free” relating to Motorola’s handset division, and most came to the simple conclusion this was more of a patent play for operating system dominance and the epic battle for supremacy between GOOG’s Android platform and AAPL‘s iOS.  

The deal caused many investors to question who is next and who needs to buy what to keep up increasingly expensive intellectual property. The first and most obvious choices for scale and IP are NOK and RIMM, both beleaguered as Android and iOS have eaten their lunch. MSFT likely has an advantage with NOK as earlier this year they signed an extensive partnership to put MSFT’s mobile OS on NOK phones, but RIMM, due to it’s ever-decreasing market cap and the company’s stand-alone status being called into question could be the most interesting and easiest to take out for a larger player.

MSFT, CSCO, Samsung and even AAPL could all be interested in RIMM’s IP and help them leap frog their next closest competitor in the mobile space. We are in uncertain times, and the idea of owning a stock for the hope that it gets taken out in a weak economy with the backdrop of weak fundamentals, RIMM seems like a difficult thing to own here, even at 4 year lows.

My sense that any deal for RIMM would largely be in cash as MSFT has over $53billion, AAPL $76 billion, CSCO $45 billion and that presents opportunities for option players as they idea of selling long dated options in the face of a take out could add some bang for your buck……Let me explain….

Lets say you thought RIMM with a current market capitalization of ~$14billion (net of cash $11.5billion), and if you thought that a 50% premium (slightly below GOOG’s 60% for MMI) seemed appropriate than that would get you to a roughly $20billion dollar deal and stock price close to $40. If you also thought given the rush for larger players to acquire IP, this could happen by year end then it could make sense to look to a structure called a diagonal calendar call spread.

MY VIEW:  RIMM could very well be in play, and there are plenty of potential suitors, what I am not sure is what the huge rush is.  The company is in a really tight spot here, much like PALM a year ago and at this point they should sell themselves before competitors stop valuing their installed base and just want to focus on their patent portfolio.  I wouldn’t buy the stock here hoping for a deal as it has rallied about 20% from its recent lows, but i would consider the following  structure.  Ideally I want to wait to put this trade on when the stock is back below 25 where it was prior to the GOOG/MMI announcement and will let you know when I put it on, I wanted to get this structure out there for those of you who may have more conviction on the potential for a deal than I have at the moment.

TRADE: RIMM ~$27.00 Buy RIMM Jan12 30 / Jan13 40 Call Spread for Even Money

-Buy Jan12 30 Call for ~3.50

-Sell Jan13 40 Call at ~3.50

Break-Even on Jan12 Expiration:

Loses: below 30 your Jan12 call expires worthless and you are short the Jan13 40 call and you have a decision to make, either cover the call or buy another call to turn back into a call spread as you still believe there is a chance of a deal…. the Jan13 will most definitely have lost value from a decay perspective and possibly from a delta perspective as the option market says their is about a 36% chance that the call is in the money on Jan13 expiration and the option will move up or down about .36 for every dollar that the stock moves.

Worst case though is that on Jan12 expiration the Jan12 30 call is worthless and you buy back the Jan13 call for less than what you sold it for.

Profits: if the stock is 30 or higher u can make up to the difference between the call premium that you own in Jan12 and the premium that you are short in Jan13. But here is the kicker lets say you get a $40 cash bid for RIMM by Jan12 expiration, all of the time value in the Jan13 call should basically go to almost nothing if their is a near certainty the deal will go through…..In this instance the Jan12 30 call will be trading like stock at about a 90 delta and the Jan13 40 call will be trading at possibly a sub 40 delta if the market assumes that there are not other bidders and the deal will close well before Jan13 expiration.

So the best case is that there is a $40 deal by Jan12 and the Jan12 30 calls will be worth close to $10 and the Jan13 40 calls will be offered below $1 and you make the difference and risked nothing to do it!

Obviously this trade would take some trade management if there was a deal or not, and the most important thing is that you don’t let the jan12 call expire worthless and leave the jan13 call naked short.