Did BlackBerry’s Weak Q1 Numbers Strengthen The Case For A Sale?


Skepticism surrounding BlackBerry‘s (NASDAQ:BBRY) turnaround plan appears to have mounted, after it missed Q1 FY 2016 earnings and revenue expectations last week. The miss was driven by weak uptake of its two new flagship devices, plummeting Service Access Fee revenues and a lack of clarity around what is driving the software division that houses the Blackberry Enterprise Server (BES) software the company is betting its growth on. While it’s possible that BlackBerry could eventually drive core software sales to offset service revenue declines, driving a long term valuation upside through earnings growth will be challenging, since BES is essentially a bet on the small and intensely competitive enterprise mobility management (EMM) market. In our view, the recent earnings actually make a strong case for a sale of the company, either outright or even in parts, since its rich technology assets are likely to be more valuable to an acquirer than they would be to BlackBerry internally. Investors also may prefer to trade off an uncertain long-term upside from EPS growth for a sizable (and certain) premium over the current market price that could come with an acquisition.

We remain neutral on BlackBerry’s stock, with a price estimate of about $9 based on our discounted cash flow model.

See our complete analysis for BlackBerry here

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BlackBerry Revenue Mix

Core Software Sales A Slow Starter

Although quarterly software revenues grew by over 150% year-over-year, to about $137 million, much of the growth apparently came from two patent cross-licensing deals, which BlackBerry now includes under software revenues. Blackberry set a target of $500 million in software revenue for FY 2016, and we assumed that this would be for the core software business including BES software, related value added offerings and QNX products. However, BlackBerry has now clubbed technology licensing revenue with software revenue. While this makes the $500 million target slightly easier to achieve, it does point to weaker than expected core software growth. BlackBerry hasn’t been forthcoming with any hard numbers for the BES business, and the market’s apprehension regarding the lack of transparency is palpable, with the stock falling by 10% since the earnings release.

Seeking Alpha contributor Elephant Analytics estimates core software revenue at between $66 million and $70 million, marking a slight sequential decline. [1] So that would mean that much of BlackBerry’s software growth came from two patent deals with Cisco Systems and a second unnamed company. The higher technology licensing revenues are certainly a positive for the company, since they are likely to be quite accretive from an earnings perspective, potentially adding directly to the bottom line, with few related costs. However, there are downsides to this as well. Unlike BlackBerry’s core EMM business, which should see revenue stickiness owing to its subscription based model, there’s likely to be a lot more volatility in technology licensing revenues. BlackBerry hasn’t indicated whether these revenues will be recurring.

Investors May Be Better Off With A Sale, Even If Software Sales Improve

BlackBerry has indicated that the $500 million software target is back loaded, and it is likely that we will have to wait until Q3 FY 2016 to see how the core business is progressing. That said, even if Blackberry is able to kick-start its BES sales later this year, it’s unlikely to drive meaningful earnings growth. 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 quickly. [2] For perspective, that’s less than half of BlackBerry’s $3.3 billion in FY2015 revenue. Competition in the EMM market is also fierce, and according to Gartner’s 2015 EMM Magic Quadrant report, BlackBerry remains a niche player in the space. [3]

Put simply, we don’t see a very significant value upside coming from near-to-medium term earnings growth, and we believe that shareholders could realize the best upside through a potential sell-out, either as a whole or in parts. 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. BlackBerry is no longer in financial distress -generating positive free cash flow and holding over $3 billion in cash and investments – 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 (related: A Look At BlackBerry’s Internet of Things Strategy). BlackBerry’s stock has also remained listless since early 2014, trading between $8 and $11, and investors could be better off with apremium that may come with an acquisition.

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Notes:
  1. BlackBerry: A Look At Software Revenue Results And Changes, Seeking Alpha, June 2015 []
  2. BlackBerry, Samsung Join Forces on Mobile Security, WSJ, November 2015 []
  3. 2015 Gartner EMM Magic Quadrant: Whats Changed Since 2014?, Solutions Review, June 2015 []