As if Research in Motion’s (NASDAQ:RIMM) hardware troubles were not enough, it is also facing some serious headwinds in its relatively stronger BlackBerry service business. The beleaguered Canadian handset maker, which made a name for itself with the revolutionary push email concept, revealed during the latest earnings call that it is under pressure from carriers to reduce its monthly infrastructure access fees. With its handset business floundering amid a delay in the launch of the BB10 smartphones and heightened competition from rivals such as Apple’s (NASDAQ:AAPL) iPhone and Google’s (NASDAQ:GOOG) Android smartphones, a reduction in carrier fees could severely dent the service business that is RIM’s best hope of tiding over this tough transition period.
The BlackBerry services, which include push e-mail and BBM, is RIM’s most valuable division currently, accounting for more than 40% of our $12 price estimate for the stock. We believe that these services are unique value propositions for RIM’s customers who pay to access BlackBerry’s secure network. No other handset maker has such a revenue stream. However, service fees for both retail and business subscribers have been declining at a fast rate as bulk contracts with enterprises and increasing presence in emerging markets resulted in a lowering of average revenue per subscriber.
This did not matter as long as BlackBerry handsets did well and subscriber growth made up for the decline in per subscriber fees.
BlackBerry sales plummet
However, RIM has now seen its BlackBerry revenues fall y-o-y for the past four consecutive quarters. Last quarter saw RIM shipping only 7.8 million smartphones, a precipitous drop of 40% y-o-y and 30% q-o-q. The BB7 smartphone that was launched late last year isn’t doing well in developed markets, where the customers are upgrading to the iPhone and other Android-based smartphones. And the emerging markets, where entry-level smartphones have sold relatively well, are subject to pricing pressures from competitors.
And now, with the BB10 OS launch pushed to the first quarter of 2013, RIM will be subject to even greater competitive pressures as the iPhone 5, Windows Phone 8 handsets, and a slew of improved Android smartphones will have been launched between now and then. The competitive pressure will come not only from potential customers who might decide to purchase rival smartphones, but also from developers who may be put off by the management’s constant change of stance.
RIM dependent on services to make up for hardware slump
As a result, BlackBerry’s subscriber base which has grown at an average annual rate of over 60% in the last four years will grow by only about 15% this year and even lower in the coming years as per our estimates. This diminishing clout of the BlackBerry is probably what is putting added pressure on RIM to reduce its fees in order to to keep its 78 million current installed base intact to upgrade to BB10 later.
While having a huge subscriber base ready to upgrade to its new platform is no doubt a good thing, RIM needs to have cash on hand to tide over this difficult transition period. While the company has so far managed its working capital well enough to generate positive cash flows and has a healthy cash balance of over $2.2 billion as of last quarter, it may not take long for the company to burn through all that considering how quickly its handset business has declined. In the most recent quarter, RIM reported a gross margin of only 28%. With gross margin for RIM’s services and software business in the 75-85% range, it is very likely that RIM sold BlackBerry handsets at less than cost last quarter.
With the handset business burning cash, lower service fees will make it much harder for RIM to keep the boat afloat long enough to reap the potential benefits of the BB10 launch.