Here’s a column I posted at globeandmail.com about RIM’s partnership with Palm:
“For something that seemed like a blockbuster deal, the announcement that Research In Motion would license its BlackBerry email software to handheld maker (and competitor) Palm Inc. did surprisingly little to boost RIM’s stock price. After spiking by a small amount on Monday, the shares drifted back down to about where they were a week ago, which is about 20-per-cent lower than they were in September, and in fact isn’t that far off the 52-week low of $60 (U.S.) the shares hit in March. Why would a deal to license its software to Palm — a company that virtually invented the handheld market, and has one of the hottest devices going in its Treo 650 smart-phone — cause such a muted reaction from the stock market?
There are a couple of possible explanations. One favoured by some analysts who follow the company is that this deal has already been “priced in” to the stock, which means that investors were more or less expecting RIM and Palm to do a deal. After all, RIM just recently signed a similar arrangement with cellphone-handset leader Nokia, so Palm shouldn’t have come as a surprise. That’s difficult to rationalize, however, considering the company’s share price is down by about 20 per cent. What else was being “priced in” to the stock that isn’t being priced in any more? Another possibility is that investors are more concerned with the ongoing litigation between RIM and NTP, the U.S. company that claims it holds a patent on wireless e-mail technology.
There’s a third concern that should be on that list (although it may or may not have occurred to some investors), and that is the fact that licensing deals such as the one with Palm represent a double-edged sword for the Waterloo, Ontario-based company. While they increase the penetration of its BlackBerry software, they also lend a helping hand to major competitors such as Palm and Nokia — and that threatens the business that accounts for 70 per cent of RIM’s revenue, which happens to be the sale of hardware. In other words, every sale of a license through the BlackBerry Connect program (which has been around for several years) assists in the cannibalization of RIM’s core business.
It’s true that Research In Motion gets a large proportion of its revenue and profit from the BlackBerry e-mail service as well as the actual hardware sale, so in that sense a licensing deal such as the one with Palm could still produce a significant return for RIM. But it’s also true that the company doesn’t make anywhere near as much money on software and service as it does on hardware. What that means in practical terms is that RIM has to sell more and more licenses to use its software in order to make up for the loss of hardware sales that a deal with Nokia or Palm represents.
According to Pablo Perez-Fernandez, an analyst with Think Equity Research, RIM makes an average of $350 for every hardware sale, plus $10 a month for the e-mail service, which works out to $380 per quarter. With just a licensing deal, the company makes only the $10 per month — which amounts to $30 per quarter. That means RIM would have to sign 13 new BlackBerry Connect licensing deals just to make up for the loss of one hardware sale. Even if you assume that the profit margins are a lot higher on the software and service side than on the hardware side (which they almost certainly are), it still means that RIM has to sell more and more just to stay in the same place. And investors aren’t expecting the company’s sales to remain flat — they are expecting growth.
RIM and its fans would like to argue that the handheld maker can continue to grow at the kind of rates it has in the past, even as it is licensing its software to companies such as Palm and Nokia (and likely Motorola soon as well), but that seems overly optimistic, to say the least. Even if the market for wireless e-mail devices is growing exponentially, a certain proportion of the sales of Nokia e-mail-enabled phones and Palm devices running the BlackBerry software will represent lost sales for RIM. Can it make as much or more money as it becomes a software vendor rather than a hardware company? That’s the big gamble.
Followers of handheld history know that Palm itself faced a similar conundrum, since it too was both a hardware and a software maker, and therefore competed with the same companies that used its software. RIM co-CEO Jim Balsillie has said that RIM’s hardware sales aren’t really big enough to make any of its big partners worried, but that isn’t really the point. The point is that as those big companies eat into RIM’s hardware business, it has to sell more and more software to make up the difference. Palm solved the problem by spinning off its software business and focusing on hardware, and now it has signed a deal with Microsoft to use its mobile operating system. How will RIM deal with the inherent conflict between the two sides of its business?