BlackBerry Q2 Earnings: Reviewing Software Outlook And The Android Strategy

BlackBerry (NASDAQ:BBRY) posted a tough set of Q2 FY’16 results, as its hardware and service access fee revenues continued to decline sharply (~50%), amid a weak uptake of its new flagship handsets and continuing subscriber attrition from the legacy BB7 platform. ^[1] Although the fledgling software business – on which the company is betting its turnaround – saw modest revenue growth (18% year-over-year), the results fell short of expectations, as sales of the core BlackBerry Enterprise Server 12 solution seemed to remain sluggish. Financials aside, the most interesting aspect of the earnings release was the company’s official announcement that it would be launching its own Android-powered smartphone by the end of this year, as it looks to revive consumer interest in its struggling handset business. In this note, we take a look at the performance of BlackBerry’s software unit and analyze the potential impacts of the company’s Android bet.

We have a $9 price estimate for BlackBerry, which is significantly ahead of the current market price. We are currently revisiting our price estimate to account for the earnings release.

Putting Software Growth Into Perspective

BlackBerry’s software and services business – which primarily sells enterprise mobility management and secure communications software – saw revenues grow by 17.7% year-over-year to $73 million in Q2. While BlackBerry doesn’t break out its software numbers, it looks like the core BES 12 offering is struggling to gain traction, amid intense competition in the small and fragmented enterprise mobility management market. In dollar terms, year-over-year growth in software revenues stands at just $11 million, which is very weak considering that the company has closed three tuck-in acquisitions (Movirtu, SecuSmart, WatchDox) since Q2 FY 2015, in addition to kickstarting the monetization process for BlackBerry Messenger.

However, software revenues should improve meaningfully towards the back half of this year. BlackBerry has transitioned away from its perpetual pricing model into a subscription model for BES so there is likely to be more stickiness in software revenues on its recent customer wins (it added 2400 corporate customers this quarter). BlackBerry has also been putting its sizable cash hoard to use, making large acquisitions which could significantly bolster revenues. It recently closed its $250 million acquisition of AtHoc, a company specializing in secure, cloud-based communication and is on track to close its $425 million acquisition of Good Technology in November. ^[2] Additionally, the company also sees a “reasonable pipeline of opportunity” to extend its IP licensing during the second half of this year. BlackBerry actually expects its software and services revenue to offset any decline in sales from the service access fee business by fiscal Q4 and noted that it expects to return to quarterly profitability on a non-GAAP basis within the same timeframe. That said, we don’t see a very meaningful long-term earnings upside coming from Blackberry’s software businesses, given that most of its products are targeted at particular niches of the mobile software market, where competition is often fierce.

BlackBerry’s Android Device Makes Sense

BlackBerry’s handset business continues to flounder, amid a sluggish uptake of its new flagship handsets such as the Passport and Classic. The company recognized revenues on just 800,000 devices in Q2, down by about 60% y-o-y while while hardware revenues fell 52% to $201 million. BlackBerry OS devices held just 0.3% of the global smartphone market in CY Q2 2015, per IDC. ^[3] However, the company is looking towards a new chapter for its handset business, announcing that it would unveil an Android powered handset called the BlackBerry Priv later this year. The device is apparently targeted at the high end of the market, sporting a 5.5 inch screen with curved edges and physical QWERTY keyboard. While the move is likely to be met with some skepticism from BlackBerry loyalists, it actually makes sense from BlackBerry’s perspective.

Firstly, the device could offer customers the best of both the Android and BlackBerry platforms, by combining BlackBerry’s security, productivity and communications features with the vast Android software and app ecosystem. Secondly, adopting Android software for some of its devices could help to bring down device and software development costs for the company, since it would only need to customize Android software for its devices while adding related security and privacy features. Thirdly, although the Android smartphone space is largely commoditized, we believe that BlackBerry has a good shot at creating some product differentiation, given its software and security expertise – something the big name Android vendors lack. That said, there are some caveats as well. BlackBerry’s strategy with BB OS entails controlling the entire device stack – ranging from hardware, operating system, applications and services – giving customers a high level of confidence about the platform’s security features. However, by using Android, BlackBerry could effectively be relinquishing some of the control it has over its devices. It remains to be seen how customers in highly sensitive or regulated verticals such as government and financial services will take to these devices.

Key Earnings Takeaways:

• Revenues declined 46.5% y-o-y to $490 million
• Non-GAAP loss of $0.13 per share, Non-GAAP operating loss of $84 million
• Cash and investments balance of $3.35 billion at the end Q2, an increase of $37 million over Q1 after using $47 million for share repurchases.
• Positive free cash flow of $100 million in the quarter

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1. BlackBerry Press Release [↩]
2. BlackBerry’s (BBRY) CEO John Chen on Q2 2016 Results – Earnings Call Transcript, Seeking Alpha, September 2015 [↩]
3. Smartphone OS Market Share, 2015 Q2, IDC [↩]