Monday Note

You’re under oath. The opposing attorney asks you: What did you know and when did you know it? Big Trouble. The legal eagle already knows the answer, that’s the basic rule: Only ask questions you know the answers to. You’re about to incriminate yourself.

This is what Mike Lazaridis and Jim Balsillie, RIM co-CEOs, are likely to face. They’ve been in legal jeopardy before: In 2009, they paid hefty penalties for backdating stock-options. But that’s nothing compared to what awaits them after RIM’s 21% share price drop on Friday, June 17th.

Far from new, shareholder lawsuits are becoming routine. Announce bad results and a specialized law firm files a class action suit on behalf of aggrieved shareholders. The savviest of these firms keep small-scale shareholders on retainer, ready to be proffered as representatives of the injured class.

Excessive — and sometimes downright unethical — class action suits are part of the cost of doing business as a publicly-traded company. Even the most frivolous claim eats up time and money. Better to settle, to make a deal between greedy but knowledgeable attorneys rather than expose yourself to the unpredictable reaction of a jury of your ‘‘peers’’, retirees barely making do on Social Security who see your millions as ill-gotten.

But for Lazaridis and Balsillie, the What and When Question is an exceptionally dangerous one.

On April 29th they issued a profit warning. They told shareholders that shipments for the current quarter would be “slightly below” the expected $5.2B to $5.6B, and that profit per share would take a 12% nosedive compared to the numbers they had forecast a mere four weeks before.

The RIMM ticker symbol lost 14% on the spot. All the while, RIM execs stuck to their yearly Earnings Per Share pronouncement (and I’m paraphrasing): “It’s a tough transition right now, but we’ll get through it. We have great products on the horizon and we stand by our $7.50 EPS number for the year!”

Six weeks later, that sunny analysis has became inoperative (“Not incorrect, not misinformed, not untrue—simply inoperative.”) Revenue has fallen to $4.9B and the outlook for the following quarter is even bleaker. Revenue will continue to fall for the year, no unit shipment forecast has been given, and the EPS estimate for the year was finally cut by 25%, to between $5.25 and $6.

This is nonsense, and it’s what makes the What and When question particularly dangerous for Mssrs. Lazaridis and Balsillie.

For the first half of the FY 2012 year, EPS will end up at about $2 ($1.33 for Q1 and somewhere between $.75 and $1.05 for Q2). How can anyone believe the sinking ship will suddenly right itself and produce an EPS between $3 and $4 for the second half as BlackBerry shipments continue to sink?

But, they’ll say, we have PlayBook shipments: 500,000 so far, with a 67% growth in International Revenues.

Do you smell “channel stuffing”?

To make your numbers at the end of the quarter, one is tempted to force-ship product into channels ahead of their actual needs, before the actual ‘‘sell-out’’ to real customers. Eventually, the channels barf and embarrassing numbers emerge.

For the PlayBook, RIM is spectacularly silent about units sold vs. units shipped. Given that the co-CEOs have never been shy about actual or fantasized feats, their caution on the number of PlayBooks actually sold is notable.

The same applies for the claimed 67% growth in international sales. Who knows how many of these have been shipped as a way to meet quarterly goals, but yet sit in carriers’ or distributors’ inventories?

Further, as we speak, low-end Android smartphones are coming to developing markets in very large numbers and are likely to further devastate RIM’s international business. See Amol Sarva’s piece on “Shanzai Blackberries’’. (Amol is the CEO of Peek, a mobile e-mail device company; his views on BlackBerry could be seen as biased, but the facts he cites are facts nonetheless.)

All this boils down to yet another possible profit warning as BlackBerry smartphones and PlayBook tablet sales fail to rise and restore earnings.

Back to the legal challenges: I think they’re serious. From March to late April to June, the numbers continued to fall. Shareholders–and their attornies–will demand emails and other documents, they’ll want to show that RIM execs “knew or should have known’’ that their public statements were incorrect. If the misstatements were deliberate, that’s fraud; even “good-faith” mistakes constitute reckless misconduct. Both are actionable, meaning expensive settlements and/or ejection.

How did we get there? Is this yet another example of the Incumbent’s Curse?:

“The Incumbent’s Curse works like a neurotransmitter disease: it starts slowly, there is no brutal onset of symptoms. The patient’s good health of the moment encourages denial; but when the malady becomes obvious it’s hard to combat, it’s often too late.”

RIM has much to proud of. They invented the smartphone. Not Palm with the Treo, a result of the Handspring acquisition; not Microsoft with Windows Mobile; not even Nokia with EPOC, the OS purchased from Psion via the Symbian clusterf#^k, the Nokia+Motorola+Sony Ericsson joint venture.

RIM started as a pager company and evolved into the best everyday device, offering unparalleled Exchange connectivity, seamlessly and wirelessly running the Holy Triad of email, contacts. and calendar services. For years, I’ve been a happy BlackBerry user and have wholeheartedly encouraged family members and friends to join the “CrackBerry” fold.

But then two modern platforms, Android and iOS, upended the status quo and caused deep trouble for RIM, Palm, Nokia, and Microsoft. Initial denials and sneers notwithstanding, the elders had to do something.

Palm was swept up by HP.

Microsoft and Nokia finally decided to get married.

RIM kept insisting its platform was best-of-breed and would continue to do great things. Last year, the company finally decided to switch horses. They acquired QNX and started the difficult, dangerous process of moving its smartphones to a new OS. Just as Nokia osborned its Symbian devices while waiting for the Windows Phone rescue, RIM kept bragging about future QNX-based “superphones” and a tablet, also running on QNX, that would be “three to four times faster than the iPad”.

But, as RIM execs just told us — again — the transition to the new superphones will take longer than expected. As for the killer tablet, it still misses a native email client and, because of a paucity of native apps, it will have to resort to an emulator running Android tablet apps on the QNX-based Playbook. (A clear message to would-be PlayBook developers: Go Android.)

In the optimistic scenario, QNX BlackBerries and PlayBooks will be ship-ready — really! — by September 2011. Carriers, distributors, developers, enterprise customers, and consumers who had deserted the platform will return in droves, and the RIM execs who have insisted that their achievements are underappreciated will finally be vindicated. See what Lazaridis said to the NY Times last April:

“Why is it that people don’t appreciate our profits? Why is it that people don’t appreciate our growth? Why is it that people don’t appreciate the fact that we spent the last four years going global? Why is it that people don’t appreciate that we have 500 carriers in 170 countries with products in almost 30 languages?”
He wrapped up with “I don’t fully understand why there’s this negative sentiment, and I just don’t have the time to battle it.

The execs are partly right: RIM is an amazing success story. And the company is still profitable with about $3B in cash.

But, unfortunately, they’re also dangerously wrong. RIM has been an amazing story, but its leaders have been in denial for too long, they have failed to recognized how two from-stratch platforms were able to move much faster than the incumbent, with its need to preserve the past while trying to build an incompatible future at the same time.

Furthermore, there’s the company’s culture. Every software developer I know who’s either worked with RIM or has considered doing so, dismisses the company as not just arrogant but tone-deaf. RIM thinks they “get” software and applications developers, but their top management doesn’t. Ex-employees, with the usual caution for the opinions of departed workers, say similar things: ‘’Research In Motion’s collapse can be traced straight to the top of the company.’’

We’ll soon find out what shareholders decide to do — besides running away.

—JLG@mondaynote.com

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