BlackBerry Fairly Valued At $9 Given Renewed Enterprise Focus And OpEx Restructuring

BlackBerry’s (NASDAQ:BBRY) shares have rallied more than 50% since the last earnings release on increasing optimism around new CEO John Chen’s turnaround strategy. The embattled smartphone maker has seen its market share as well as subscriber base decline sharply in recent quarters, as BB10 failed to deliver results in the face of heightened competition from the iPhone and Android-based devices. BlackBerry’s service ARPU (average revenue per user) figures have taken a hit as well, with the company lowering its prices to hold on to subscribers and the subscriber mix shifting from high-end unlimited plans to prepaid and lower tiered plans in emerging markets. Additionally, with the bring-your-own-device (BYOD) trend gaining momentum, enterprises with less stringent security requirements are warming up to the idea of employees bringing their personal devices to work. While this threatens BlackBerry’s niche, the company is counting on the loyalty of a big but declining base of government institutions and corporations that are reluctant to migrate to rival platforms due to their huge scale and security concerns.

The services part of BlackBerry’s business is its most valuable currently, accounting for about 40% of its total value by our estimates. With its retail aspirations taking a beating, the company is retreating to its enterprise stronghold in a bid to stabilize its business and survive after plans to sell itself to Fairfax Financial fell through. With a new CEO at the helm, BlackBerry is looking to target a much-reduced but focused customer demographic in enterprises by promoting its service portfolio in security and mobile device management (MDM) solutions while reducing its future smartphone portfolio from 6 to 4 devices. The company is also distancing itself from the devices business by outsourcing the development and manufacture of hardware to contract supplier Foxconn, which should help mitigate the impact of its slumping device sales. Additionally, the ongoing restructuring, that is expected to trim BlackBerry’s workforce by a third in the coming months, will go a long way in helping the company realize significant cost savings to fund its turnaround plan. Our $9 price estimate for BlackBerry is about in line with the current market price after the recent run-up.

See our complete analysis for BlackBerry here

Enterprise Subscriber Mix On The Rise

BB10’s failure to spur demand in a consumer market heavily dominated by the iPhone and Android-based smartphones has left BlackBerry with few options but to double down on its enterprise niche. The company has seen its subscriber numbers fall rapidly in recent quarters, but we believe that most of the losses have come from the retail side rather than enterprise. BlackBerry stopped revealing its subscriber figures after the end of the May quarter, when its subscriber base declined from 76 million to 72 million. However, it recently provided color that the quarterly decline has been fairly consistent since then, in the low-to-mid-teens. Assuming a decline of 12.5% in each of the last two quarters, BlackBerry’s installed subscriber base is likely to have fallen from 72 million at the end of the May quarter to about 55 million currently. The extent of the decline points mostly to the weakness that BlackBerry is seeing in the consumer device market, especially in developed regions. Last quarter, BlackBerry saw its handset sales decline by over 70% year-on-year, with only about 25% of those sold through to end customers being high-end BB10 devices.

Although emerging markets have helped BlackBerry move more of its device units, this isn’t reflected in the company’s geographic revenue mix. Last quarter, the contribution of North America and EMEA to BlackBerry’s overall revenues increased to around 75% from 66% a year ago. While this could partly be attributed to the lower prices of BB7 handsets sold in emerging markets, a bulk of the increase in mix is likely to have occurred due to the higher concentration of BlackBerry’s enterprise customers in North America and Europe, where subscriber losses seem to have not been as drastic. We estimate that the company’s business subscriber mix increased from around 40% in 2012 to 45% last year, as BB’s enterprise subscriber base remained nearly constant at 30 million while retail accounted for the bulk of the subscriber defections to rival platforms. BlackBerry’s turnaround plans revolve around making the most of this enterprise niche.

BB Looks To Hold On To Enterprise Niche

However, BlackBerry faces significant roadblocks here given that the enterprise landscape is changing fast, with IT administrators increasingly accommodating employees that bring their own devices to work. Although BlackBerry’s installed base is big, it is losing share to Apple and Samsung among the devices being sold to businesses and their employees. Globally, its business devices market share has declined from over 30% in 2010 to about 8% in three years, according to IDC. ^[1] While device sales are likely to decline further, BlackBerry could still benefit from having a large installed BES (Blackberry Enterprise Services) base with a proven mobile device management software (MDM) that now has cross-platform support. This is invaluable to large security-conscious enterprises and government organizations that do not want to undertake the complex process of transitioning all their devices to a different management solution. Last month, the U.S. Defense Department made a large commitment to BlackBerry, saying that it will add 80,000 BB handsets to its network by the end of the month, as compared to only 1,800 based on iOS and Android.

Going forward, we expect BlackBerry’s renewed enterprise efforts to help the company hold on to around two-thirds (or 20 million) of its business subscribers by the end of our forecast period, while retail drops to nearly zero. However, if the company manages to market its cross-platform MDM support well, it might end up retaining a bigger portion of its enterprise base than we expect. If BlackBerry succeeds in holding on to all its enterprise subscribers, there could be a 10% upside to our price estimate. The inherent assumption here is that, in order to retain subscribers, BlackBerry will have to lower the prices of its service plans or offer tiers which reflect the different levels of its security and MDM value-added services. As a result of this, we expect BlackBerry’s enterprise service ARPUs to nearly halve from current levels by the end of our forecast period.

Foxconn Agreement and Restructuring To Limit Near-Term Losses

In order to stabilize its overall business, BlackBerry needs to stem the losses being incurred on the devices front as well. The company recently announced a five-year strategic agreement to outsource the design and manufacture of its handsets to Foxconn. Starting out, BlackBerry is offloading its device-manufacturing processes for emerging markets to Foxconn, while it focuses on the high-end enterprise device market. This may limit the long-term potential for margin upside, but it gives BlackBerry an opportunity to rein in fixed costs, minimize inventory risk, and stabilize a loss-making arm as soon as possible, while it looks to add value through its end-to-end enterprise security and BBM software solutions and services.

At the same time, BlackBerry is restructuring its operations by cutting around 4,500 jobs, which will help reduce operating costs by a half by May. BlackBerry expects the Foxconn deal as well as the restructuring to help the company become cash flow neutral from operations in FY15 and profitable by FY16 (ends Feb 2016). Not losing cash on the devices front will allow BlackBerry to invest and strengthen its enterprise software offerings. Going forward, we expect BlackBerry to run the hardware part of its business as a low-margin one that will drive its enterprise sales in much the same way as Apple runs its App Store to support iDevice margins. By our estimates, BlackBerry’s devices division accounts for only about 7% of its total value given the continued market share losses we expect in the coming years.

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1. For BlackBerry, Consumers Aren’t the Only Problem, WSJ, September 2013 [↩]