Risky Bets with Positive Expected Value

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The two companies below were once stars in their respective industries, but have fallen from the investment sky to become nearly impossible-to-explain positions for any institutional portfolio manager. The question is, do these companies represent long opportunities, or are they irremediably headed towards a sure death?

Research In Motion (NASDAQ: BBRY) is the company I had to value for my Value Investing class at Columbia Business School. By early 2011, my group and I gave the stock a price target of $30 when it was worth $56. The problem was that we had to defend our thesis against Legg Mason's Bill Miller, who was an eternal bull on the stock. We were right, RIMM's software was (is) antiquated and it lacked the ecosystem that is present in Apple's and Google's platforms.

We concluded that it was destined to become a new Nokia (NYSE: NOK) and keep on losing market share. The company, now trading at 2012 x3.5 P/E and 2013 x2.8 price to operating cash flow, seems overly cheap (NOK trades at 2012 x -53 P/E). RIMM's market capitalization is $6.2 billion against Nokia's $13.9 billion, so RIMM could be a reasonable M&A target for bigger companies willing to acquire its technology and user base. The main question here is how much value does Blackberry's perfect keyboard have for millions of users world wide? I am sure many users who have grown up with a Blackberry at their fingertips will miss it; but how much?

The way to go, in my opinion, is to play RIMM going long with call options. As for today, RIMM trades at $11.9 per share. It does not pay a dividend, and its January 2015 calls with strike at $10 are selling for $4.95. So you pay $3 to bet RIMM will be an M&A target between now and 2015. If our 2011 valuation was right (and by now the numbers are consistent with what is actually happening), an M&A price of $22 would not be exaggerated. Your loss is limited to $4.95 and you could make a killing.

First Solar (NASDAQ: FSLR) is the world's premier provider of fully integrated solar solutions. The company not only manufactures solar panels but also (and above all) is a project developer, constructor, and operator. FSLR works through the entire value chain. That said, its shares have been hit hard during the last 2 years. They are down by 80% since December 2010. Chinese competition and a falling European market can explain the lousy performance. But prospects are getting better, and 2013/2014's project pipeline gives FSLR a good cash flow stream that explains today's price. The business can be divided into the service line and manufacturing line.

Trading at a market capitalization of $2.7 billion and with net cash in its hands I think FSLR, represents a good value proposition given its extensive client list and its top of the line service level for energy buyers. FSLR trades at 2013 x2.2 price to operating cash flow and x5.5 P/E. It is the best company in a risky sector, but the company is now understanding how to build its own business. Go long, if you dare. 

The conclusion here is, if you are a risk-lover, go long on FSLR and buy January 2015 RIMM call options. You might be wrong on both bets, but at least they seem to have a positive expected value. Just don't leverage yourself and understand that this must be a very small share of your overall portfolio this bets make sense.

martinzaldua has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend First Solar. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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