BlackBerry Earnings Preview: Restructuring Progress and Service Revenues In Focus


BlackBerry (NASDAQ:BBRY) is scheduled to release its Q4 FY2014 results on March 28. The company is taking deep market share cuts on the handset front, as BB10 has failed to spur demand in a crowded marketplace in which iOS and Android continue to dominate smartphone sales. Further, a resurgent Windows Phone has been quick to take the position of the third mobile ecosystem, putting into question BlackBerry’s future as a smartphone vendor. Last quarter, BlackBerry recorded sales of only 1.9 million smartphones, about 72% fewer than what it had a year ago. As a result, BlackBerry had to take a huge $1.6 billion hit on the write-down of unsold inventory and supply commitments, primarily attributable to BB10 handsets. This added to the $934 million in inventory write-offs that the company had recorded in the previous quarter.

In order to reduce its exposure to the mobile device market and mitigate inventory risk, Blackberry has entered into a 5-year strategic partnership with Foxconn to manufacture its smartphones. The company is also restructuring operations and laying off employees, a bulk of which are likely coming from its devices division. It is also bolstering its balance sheet by selling off real estate in Canada and the U.S., and leasing back only a portion of the space to accommodate the smaller workforce. As a result of the restructuring, BlackBerry expects its operating costs to be cut in half by May. We will be closely watching the company’s margins to see if the company is on track with its expense management initiatives. Also, given that most of BlackBerry’s value lies in its services business, it will be important to see how the subscriber base is holding up and if BBM’s usage metrics have improved in the last quarter. Our $9 price estimate for BlackBerry is about in line with the current market price.

See our complete analysis for BlackBerry here


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BlackBerry-Foxconn Deal

The Foxconn deal provides BlackBerry with an invaluable opportunity to rein in fixed costs, minimize inventory risk and stabilize a loss-making arm as soon as possible while it looks to keep its smartphone brand alive in regions where it is still quite popular. BlackBerry is initially tapping Foxconn mainly for emerging markets, where Foxconn’s scale allows it to procure materials at favorable costs and play the margins game in an increasingly crowded low-end smartphone market.

Eventually, BlackBerry plans to also transition the design and manufacture of high-end smartphones to Foxconn as it focuses more on adding value through its end-to-end software suite of enterprise solutions and services. BlackBerry expects the Foxconn deal, as well as the ongoing restructuring drive, to help the company become cash flow neutral from operations in FY15 and profitable by FY16 (ends Feb 2016). However, it is unlikely that BlackBerry saw benefits from the Foxconn deal accrue in the last quarter. The first product of this partnership, the Z3, will debut next month only in Indonesia and be rolled out in other emerging markets in the subsequent weeks (see New BlackBerry Smartphones Signal Shift In Focus To Enterprise Services And BBM). Still, not burning cash on the devices front in the coming quarters will allow BlackBerry to invest and strengthen its enterprise software offerings, not just in security but also other value-added services such as BBM.

Enterprise Services And BBM Monetization

Given that BlackBerry’s services division accounts for about 40% of its value, by our estimates, this seems to be a smart move. Unlike the retail market, which is a lot more volatile in terms of consumer preferences and technology transitions, the enterprise market is stable and less prone to large-scale subscriber defections. While BlackBerry’s paying subscriber base has fallen drastically, from 79 million a year ago to an estimated 55 million by the end of last quarter, the bulk of the decline seems to have come from the consumer side, especially in developed markets (for more on the estimated subscriber declines, see BlackBerry Fairly Valued At $9 Given Renewed Enterprise Focus And OpEx Restructuring). BlackBerry’s turnaround plans revolve around making the most of this enterprise niche.

However, the Bring Your Own Device (BYOD) trend is gaining momentum, as IT administrators accommodate employees bringing 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. [1] The company has therefore added cross-platform support to its BES platform and changed its business model to charge only those customers who require advanced services such as greater security. Those who do not need such services will generate little or no revenues. As a result, we expect ARPU levels to continue to slump going forward, with retail declines being more significant than enterprise.

Where BlackBerry could still derive value from the consumer market is BBM, which was recently opened up for access to users of Android and iOS platforms. The service has since garnered around 85+ million monthly average users (MAUs) and plans to monetize it through sponsored channels and the sale of stickers and virtual goods through the new BBM store. Given the success that WeChat and Line have seen in monetizing their subscriber base by selling virtual goods, BlackBerry has a good opportunity to tap with BBM. The company is also pursuing mobile money transactions through BBM, launching BBM Money in Indonesia and expecting to add other countries in the coming months. Since BlackBerry has a secure and reliable infrastructure in place, BBM Money could be a good monetizing tool as well as a differentiating factor to have in a crowded messaging marketplace.

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