Would Shareholders Be Better Off If BlackBerry Is Acquired?

BlackBerry (NASDAQ:BBRY) surprised the markets late last month by posting a Q4 FY 2015 net profit aided by lower costs and an investment-related gain. The company’s operational progress over the last few months has been reasonably encouraging, and CEO John Chen has succeeded in giving the company a sense of direction by focusing on the core enterprise business while also cutting costs and divesting assets. However, despite the recent optimism, achieving near-term earnings growth will likely be difficult, as the company will run out of costs and inefficiencies to prune, while potentially facing challenges in stabilizing its plummeting revenue base. BlackBerry’s consensus EPS for the next two fiscal years remain negative according to Reuters, and longer-term visibility also remains weak. BlackBerry has many assets (software, intellectual property, and engineering talent) that could potentially be more valuable to a larger corporation than they would be internally. This leads us to a question: would BlackBerry shareholders be better off if the company were to be sold, either as a whole or even in parts? In this note, we explore three things: 1) The challenges that the company faces in driving earnings; 2) Why a potential sale could be beneficial for shareholders; 3) The company’s assets that would be attractive to an acquirer.

We remain neutral on BlackBerry stock, with a price estimate of about $9.50 per share based on our discounted cash flow model.

See our complete analysis for BlackBerry here

Why Driving Earnings Growth May Not Be Easy

BlackBerry’s high-margin service revenue ($310 million, or 47% of total revenue in Q4) has been falling fast, and the company projects 15% quarterly declines going forward as subscribers leave the platform. The company intends to replace this with revenue from its fledgling software division ($67 million in revenues for Q4) that primarily sells its BES enterprise mobility management (EMM) software. However, the plans to more than double software revenue to about $600 million in FY2016 will not be easy, given the intense competition in the mobility management space and the relatively slow monetization of the company’s EZ Pass program for BES. Citigroup analysts estimate that the company has likely converted just 1 to 1.6 million of its 6.8 million customers on the EZ Pass promotional program into paying customers. ^[1] Moreover , EMM represents a small and relatively niche market in the broader mobile software space, as the global market stood at under $1.5 billion last year, although it is growing relatively quickly. ^[2] For perspective, that’s less than half of BlackBerry’s $3.3 billion in FY2015 revenue. Additionally, the company’s hardware business (42% of total revenue in Q4) has also been regularly missing revenue expectations, and we don’t see the niche new releases (Classic and Passport) as driving significant volume growth, although they should help to bolster ASPs and margins. Put simply, we don’t see a very significant value upside coming from near-term earnings growth.

Why An Acquisition Could Make More Sense Now

While the possibility of an acquisition has cropped up before (Fairfax in 2013; Samsung rumors earlier this year), a potential transaction would still make sense for shareholders. The company is no longer in financial distress (Q4 cash flow of $76 million, cash balance of $3.27 billion) and it should have better leverage while negotiating with a potential suitor. Additionally, the company’s technology portfolio is heavily geared towards currently hot trends – such as secure communications and the Internet of Things – making it even more attractive to a potential acquirer. BlackBerry’s stock has remained listless over the last 18 months, largely trading between $8 and $11, and investors could be better off with a significant premium that could come with an acquisition. Additionally, an acquisition would remove the risks and uncertainties associated with the company’s ongoing transition. In other words, shareholders may prefer to trade off a somewhat uncertain long-term upside from EPS growth for a sizable (and certain) premium over the current market price that could come with an acquisition.

Valuable Assets Could Be Better Monetized Outside The Company

Portfolio of Basic Wireless Patents: BlackBerry has a portfolio of about 44,000 patents which include technologies relating to security and basic wireless communications. Many of the company’s patents relate to foundation technologies in the mobile communication space, where lawsuits over basic technologies have been abundant. ((BlackBerry’s Patent Portfolio Is Wireless Trove for Acquirer, Bloomberg, January 2015)) While BlackBerry’s patents had a net book value of around $1.43 billion as of August last year, their market value could be significantly higher. Given the small size of BlackBerry’s smartphone business (roughly 7 million devices sold in 2014 versus over 1.2 billion smartphones shipped globally) and weak monetization of intellectual property, these assets may be more valuable to a larger player. Buying a company for its intellectual property is an oft-used tactic in the technology industry, and BlackBerry’s patents could prove useful as a bargaining chip for a potential acquirer in the event of litigation with rival manufacturers. For instance, China’s fast-growing local manufacturers – who have increasing global ambitions and weak intellectual property – could find some patents valuable.

Security Technologies And IP: BlackBerry has a reputation for cutting edge security with its encryption technology, device management software and secure global network infrastructure. The company’s security offerings and related intellectual property are likely to be highly valued given the increasing concerns of security breaches, surveillance and data theft in the broader technology industry. The company has also been bolstering its security offerings over the last few quarters, recently purchasing Secusmart, a German mobile security company that provides high-security voice and data encryption and anti-eavesdropping technologies. While BlackBerry itself has been forging partnerships to drive deployment of its enterprise and security software assets, they could be more valuable to a third party with a larger revenue base. For instance, an acquirer could emphasize security in order to create product differentiation and attract new customers.

QNX and IoT Assets: The Internet of Things (IoT) refers to the idea that everyday products such as home appliances and industrial equipment are connected to the Internet and are able to communicate with one another. According to market research firm Gartner, the number of connected devices globally will rise from about 5 billion in 2015 to 25 billion by 2020. Several companies, including Samsung, IBM and industrial behemoths like General Electric, are making big bets on IoT. For example, Samsung intends to equip 90% of all its devices with IoT capabilities by 2017 while IBM intends to invest about $3 billion towards a new IoT unit. Software and services represent a crucial part of the IoT puzzle and BlackBerry’s related assets could be increasingly valuable to companies looking to take the plunge into the space. BlackBerry has a tried-and-tested operating system that can power networked devices in QNX, which runs embedded systems in cars, industrial applications, and medical devices. The company also has its roots in the efficient and secure delivery of data, via the messaging and security functions of its secure global network infrastructure. BlackBerry’s experience in developing operating systems and user interfaces could also prove valuable for a potential acquirer. (related: A Look At BlackBerry’s Internet of Things Strategy) The monetization of QNX has been weak thus far, and IHS analysts had previously estimated fees to be a paltry $3 per licence in the automobile space.

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1. BlackBerry Drops 8%: RBC’s Upbeat, But Street Mostly Still Skeptical on Software, Barrons, March 2015 [↩]
2. BlackBerry, Samsung Join Forces on Mobile Security, WSJ, November 2015 [↩]