Should RIM Issue Dividends? The Case For and Against

I've noticed that a lot of traffic directed to my site from search engines is from people searching RIM and dividend. I thought that raised an interesting question and I think it warrants a quick analysis.

The Case For Dividends

Although RIM is a technology company, it's hardly some new up-start. They have a strong product development line in hardware (regular planned obsolescence), their software and data models are profitable and inimitable (from an mobility and security perspective) and their company appears to have a long run way. They are very mature in this space.

However, very few (if any) companies in the technology space issue dividends. Why? Growth in this industry is still pretty rapid and companies are using their cash for R&D. Plus they don't have to. Investor's are happy with the capital gains returns from the stock movement based on the long term potential.

By issuing dividends, RIM could signal to the market that it is a mature leader in the technology space. This would attract a new type of investor to their stock, and signal that RIM is a stable company. This type of move should prevent gigantic drops to $44 that we saw earlier last month.

The Case Against

RIM's growth and cash base is still so tremendous (new subscriber base is constantly growing) that issuing a dividend would have some negative effects on investors perceptions. "Maturity" in a market place isn't always something to brag about, especially in RIM's case where a huge portion of their price (if not all of it) is based on the fact that they are growing (enjoying high PE multiples).

Also, investors should ask themselves: "After all that trouble to raise capital, you're giving it back to us?"

Plus, in this recessionary environment where cash is king, RIM should be using the money (at the very least) to acquire companies such as Certicom inexpensively to bolster their strategic offering.

Resolution:

If you look at the math formulas for dividend payout versus retention ratio, based on RIM's growth it doesn't make sense to pay out dividends (thus reducing the retention ratio) because they still have a tremendous growth rate and they need the cash to fuel it.

I think it would *eventually* be a good idea for RIM to issue dividends: 5 to 10 years out. Probably starting with a one-time dividend approved by their board and slowly moving towards a regularly quarterly dividend (but that is more than a decade out).

But who knows? With the pace and development of our economy and technology, wireless data is becoming as common and stable as McDonald's hamburgers.

RIM up $13+ from 60+ to $73+

Well I feel vindicated. RIM reports strong earnings and the stock goes back up closer to my $75 target. Now I need to review the earnings report and evaluate my model to see where the valuation comes out.

Despite that, I expect that the stock will probably be a hold (or a sell for people looking to make a quick buck).

MD&A points to a strong next quarter and I would believe that. Major carriers like Rogers are under attack from low cost providers like Koodo (in Canada) and there are a multitude of good reasons for them to increase their strategy in the wireless data space:

• BlackBerry wireless data is not available on pay as you go plans (contracts needed)
  
• Profit margins for wireless data are extremely high
  
• Data transmissions require relatively infinitesimal line capacity requirements - low network usage versus voice calls

Zeller's New CEO Overly Ambitious

Zeller's new CEO, Mark Foote, is trying to pitch the public the idea that Zeller's is in a position to profit from the recession in the same way Walmart is, as the discount retailer in the HBC brand. If you read my post about why Canadian's can't seem to compete at the same levels of our American cousins, you would be (and should be) a bit skeptical.

While Mark has his direction and focus in the right area, "supplier relations" and "productivity" (as measured by sales per square inch) will hardly be easy challenges to surmount.

As far as supplier relations go, if Zeller's wants to compete with Walmart, they have a long way to go in terms of cut throat relationships to drastically cut prices that characterize successful discount retailers. Walmart has also had a good head start with "supplier relations" (notoriously so that they've constantly been targeted by activists for having "bullied" suppliers). But worst of all, Zeller's won't have the strategic leverage they can apply against their suppliers for better conditions as their parent company is having financial troubles of it's own. Also their distribution channels are not particularly noteworthy versus other retailers. It's hard to be the school yard bully if you're the skinny and sickly nerd.

In terms of "productivity", it isn't a cause of their woes, it's a symptom of their diluted brand equity. This is the consequence of their brand swaying back and forth and not entirely owning the discount space. Been to a Zeller's recently? In peak hours, there's no one there. Walmart's continue to be constantly packed. The Zeller's brand isn't even bringing people through the door.

Mr. Foote's "sanguine" attitude is encompassing and descriptive: Win or lose, The future looks both hopeful and bloody.

Profit per Employee - Understanding and Quantifying Your Worth

Face it, you don't have a job because the business you work for "enjoys your company" (unless you are an entertainer). Everyone knows that you have work to do and that you play a role in the success of the team. But these pretty words and pleasant philosophy shouldn't prevent you from trying to understand and quantifying your worth.

While some jobs may be more easily measured than others (productivity in line assembly work, revenue generation metrics for sales staff, completes in a call center etc) some maybe more difficult to classify.

However, a relatively new and unique model is being proposed based on profit per employee. By comparing the value add by your employment, what is the profit margin that employers are getting based on your current salary. For instance, if you are a a new hire what is the marginal value that the company expects your work to generate? Look at an example:

At a top engineering consulting firm, a junior engineer is hired at a salary of $60k (~$30/h). However, under the supervision of a P.Eng and colleagues, the junior engineer's work is billed at a rate or $80/h. Assuming a 75% engagement rate, the profit the organization is gaining off the junior engineer would be

Profit margin= ($60 - $30) / $30
or 100%

While this example is terribly oversimplified, it should highlight the idea that whatever your salary is, the company you are working for should be benefiting more (otherwise, the incentive to hire you disappears as does your job possibly).

If the value you calculate is completely out of whack (as compared by relevant benchmarks), it could indicate the following:

• You are adding tremendous value to the organization - time for a promotion
• You are under paid - maybe it's time for a move (conversely the organization may need to re-evaluation it's compensation programs)
• The nature of your job has high multiples on return
  
• The company may have a strategic interest in hiring more people to undertake similar work
  
• There are external factors at play - this job is attractive for other reasons - scheduling flexibility, intellectual challenge etc
  

While hardly a perfect model by any means, it does provide an interesting alternative for looking at individual performance. Also this type of mindset will really help anyone at the salary negotiating table (regardless of which side you are sitting on).

Capacity Management - Why Hotels and Airlines Deliberately Overbook

With my recent investment blog post about Air Canada current troubles, I began to look at the service industry and capacity management (a staple concern and metric of success).

Any seasoned manager in the hospitality industry is familiar with capacity management. In the services industry, maximizing capacity (as services can't be time shifted to other periods, they are either consumed or not) is a great way to increase overall profitability.


Most people would assume that hotels book until they are at 100% capacity and fill all the rooms. They are usually surprised when they find out that the hotel is over booked. How can that be? It's not operationally difficult to track the number of rooms and the number of guests! Let's explore why:


Profitability for hotels, the top two most important metrics for revenue are ARR and OCC (Average room rate and occupancy rate respectively).

Revenue = ARR x OCC

Now, many services will try to boost their ARR through marketing, improved services etc, but for this example, let's assumed it's fixed. It's quite obvious that the best way to boost revenue is to increase occupancy (have more people visit).

Now as a hotel you've booked 100% of your rooms. Great right? Well not entirely. Unfortunately, for a variety of reasons, people cancel, have no shows, etc. So your OCC drops from 100% to it's real life value (usually 70-80%). One solution to recover costs is to instigate a cancellation or no-show fee to recover some of the 20-30% of OCC lost (in the form of a 10-50% fee depending on when the cancellation is made).

Revenue = (ARR x OCC) + (Cancellation fee x number of cancellations)

Now some clever analysts determined that by trying to predict how many people would cancel, it was possible to deliberately overbook the hotel in hopes of boosting revenue. For instance, if 10% of people booking canceled, it is possible to over book the hotel proportionally so that the final result (expected visitors) would be 100% (and you could also charge cancellations the regular fee).

OCC = # of bookings x (1 - Cancellation rate)
[Target = 100%]

So if you expected 10% of people to cancel (90% show up), and you had 100 rooms, you would book about ~110 guests, expecting only 99 - 100 to show up.

However, this begins to creep into the case most of us are familiar with: more people show up than expected. In this case, the hotel has a problem. For simplicity sake, let's just say that in order to resolve this issue (upgrades, alternate accommodations, loss of good will etc) there is an "all encompassing" penalty cost of Y dollars.

The full revenue cost formula becomes:

Revenue = (ARR x OCC) + (Cancellation fee x number of cancellations)

- (# of over bookings x Y)

Now in order to maximize profit, the derivative of the revenue function is taken with respect to occupancy, to find the sweet spot where revenue is maximized. Essentially, you begin to counterbalance the benefits of maximizing occupancy with the cons of over booking.

Of course there are some major assumptions which (if refined) can provide a better picture of the profitability and costs:

• Average cancellation rate can be refined to more by accurately segregating guest demographics to improve accuracy in predictions (is cancellation affected by age, geography, time of year, other consumer qualities)
• "Cost" of overbooking (especially if it's pervasive) can be detrimental to brand quality and could adversely affect ARR (guests feel like the quality of services drop)
• Hospitality is seasonal by nature so assumptions and rules governing overbooking need to change accordingly
• Over booking assumptions for finding alternate accomodations might be prohibative if there are simply no alternates during a "hot" season

CPPIB picks up its socks and gets vindication

The Canadian Pension Plan Investment Board (CPPIB) has had some unfortunate luck when it came to making acquisitions. They were constantly outbid by rivals who applied higher levels of leverage to out bid them in LBO's. But we all know how that story ends for many of the firms out there who had too much leverage and now find themselves in deep trouble.

Well now might be CPPIB's vindication, as they start to pick up heavily discounted acquisitions which passed them by the first time around. The article cites the deal to acquire Macquarie Communications Infrastructure as a case in point. While Macquarie had gotten the better of CPPIB at the time, it appears that the tables have turned: even though CPPIB's bid assumes a relatively low valuation, it is still endorsed by the Macquarie board. While investors may reject the offer, a better question is: "Who do you expect to step in to up the price?"

I guess there is some truth in the old adage that some of the best deals are the ones that aren't made.

Timing is everything it seems and, as I've been reiterating, the PE winners in today's markets are the ones who don't have to liquidate prematurely (taking unexpected losses) and who have cash to make purchases (to realize future gains).

Reporting Positive EPS in Decline? Unusual Strength in a Time of Weakness

Many people are looking for the end of the recession, but are starting to "read into the signs" a little too much (or perhaps not enough). Some of the major US banks reported positive earnings (such as Citigroup), but analysts should be particularly careful in times like these before starting to get back into the market.

But positive earnings in a recession should be good news right? Not really. Do the math and look at the underlying story. How strong are your "earnings"? There are many common (legal) ways to inflate your EPS (which most diligent analysts will be trained to observe):

• Sale of assets / subsidiaries / securities (realization of a gain)
  
• LIFO reserve liquidation (sale of inventory that is not replaced)*
  
• Redeeming a tax deferred asset / tax deferring strategies
  
• Asset re-evaluations (highly restrictive and a generally noisy way to fix a delicate problem)
  

These strategies are generally analogous to having a garage sale or going to the pawn shop in order to pay the bills and eat. Yes, you have money coming in, but this only works for a while. Eventually, you run out of stuff to sell and you need to start making money some other way.

* Note that due to GAAP, LIFO can only be used in American companies (30% of which use this accounting method) whereas IFRS doers not permit this practice (FIFO and WAC methods only)

This list excludes illegal methods, of course, such as World Com's incorrect capitalizing of an expense. World Com wrongly capitalized in line costs that should have been expensed (and were until 2002). This resulted in an investment cashflow out rather than the proper expense reducing cash flow from operations (it's not an investment outflow expected to bring in returns as much as it is an operating expense, similar to COGS).

In times like these, it becomes even more important to use your financial ratios when evaluating the fundamentals and determine how much harder you have to work to get an extra dollar of revenue (using your operating cash flow ratios).