Why We Aren't Bullish on BlackBerry Just Yet

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BlackBerry ( BBRY ) recently posted a better than expected set of Q1 2015 earnings, indicating that its restructuring plan is certainly taking effect.  Over the past year, the company has made some meaningful headway in cutting costs and improving liquidity by selling real estate, sizing  down its workforce and subcontracting parts of its handset design and manufacturing operations. While the progress on the cost front is no doubt encouraging, we believe that the company could be running out of inefficiencies and costs to eliminate, meaning that earnings growth will have to be aided by reversing the precipitous revenue decline.

The company's revenues have fallen by around 66% year-over-year to around $966 million during Q1 2015, largely due to an 82% decline in hardware sales. Software and services revenues have also fallen by about 29%, largely due to the smaller user base for BlackBerry services. (( BlackBerry Q1 2014 Earnings News Release )) This is quite concerning, since BlackBerry has been highlighting that its software and services business will be a key driver of the company's turnaround. While the company has been reworking its strategy for its principal software and services businesses such as BlackBerry Enterprise services, BlackBerry Messenger (BBM) and the QNX software business, their monetization has yet to gather pace and we believe that it could take several quarters before we see any visible results. In this note, we analyze the key risks that BlackBerry's software and services business face in unlocking value.

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Trefis has an $8.40 price estimate for BlackBerry , which is slightly below the current market price.

BlackBerry Services Subscriber Declines, BES 12 and EZ Pass Will Need To Yield Results

BlackBerry services remain the company's most valuable business, accounting for about 54% of revenues and around 40% of the company's market capitalization, according to our estimates. The division has faced significant headwinds of late, with a subscriber base that has fallen from around 79 million in early 2013 to an estimated 50 million at the end of the last quarter. However, the company is counting on the loyalty of its large yet declining user base of government institutions and corporations, who value BlackBerry's reputation for cutting edge security and its proven mobile device management software ( MDM ), to stem the decline and drive growth going forward. Unlike the consumer market, the enterprise market for software and services is less prone to large-scale subscriber defections, since companies typically plan and invest large sums of money in their information systems, making them less susceptible to short-term technology transitions.

Stabilizing The User Base: The company has taken several initiatives to drive a turnaround in the enterprise services space. It introduced cross platform support in BES 10 in order to capitalize on the growing "bring your own device" trend (BYOD), providing support for rival platforms including Android and iOS.  The company has also been investing considerable resources in developing BES 12, which would unify support for BES 10 and BES 5, making it easy for organizations to operate both BB7 and BB10 based devices on a single infrastructure. BlackBerry also seems to be counting on its handset business to drive subscriptions to its BES service.  The company plans to launch two new high-end smartphones, dubbed Passport and Classic, later this year. However, we believe that these upgraded device and service offerings will merely serve to retain existing BES subscribers rather than entice additional users for BlackBerry services.

EZ Pass Could Hurt Monetization : BlackBerry has also been trying to attract more customers to its BES 10 platform through its EZ Pass program, which allows organizations running earlier versions of  BES  or competing Mobile Device Management ( MDM ) platforms to switch to the BES 10 offering for free. The company intends to monetize these users by eventually charging them for technical support and by encouraging them to upgrade to a premium version of the service that offers better security features. However, the program could have near-term impacts on the company's profitability, since it would not earn anything from free licensees while still providing customers with technical support.  It also remains to be seen how effectively the company is able to convert these free licensees into higher value customers.

BlackBerry Messenger Seeks To Ride The Mobile Messaging Wave, But MAU Stagnation Is An Issue

The use of mobile messaging applications has been growing rapidly, driven by higher smartphone penetration and the availability of affordable data plans in emerging markets. BlackBerry has been looking to revitalize its BBM messaging service by opening it up to rival platforms such as Android and iOS. BBM has some advantages over rival applications, including security and a proven infrastructure, voice and video calling options as well as channels that allow brands and celebrities to connect with their audience. The cross platform strategy got off to a strong start, with its active user base growing by about 20 million to about 80 million in just a few weeks following the launch.

Monthly Active User Base Has Remained Flat Of Late : We have some concerns over the company's ability to significantly expand the user base of the product. as monthly active user (MAU) growth has slowed down, and remained nearly flat over the last two quarters at around 85 million users, though the company expects this to improve to around 100 million users as the Windows version of the application launches. We believe that the slowing growth in MAUs could be due to the fact that roughly 50 million of the active BBM users are on the BlackBerry platform, which is more popular with businesses. As mentioned previously, businesses are less susceptible to short-term technology transitions, unlike the consumer market.

Monetization Plans Need To Gather Steam : BlackBerry is targeting revenues of roughly $100 million from BBM by FY 2016, and its monetization strategy is multi-pronged. The company introduced its BBM Protected offering, which provides end-to-end encrypted messaging for security-conscious enterprise users. The company is also looking to monetize its consumer user base through its mobile payments platform for BBM and advertising on its BBM channels. The company could also be looking to potentially sell off the BBM business, given the attractive valuations that mobile messaging apps have been witnessing of late. However, BBM significantly trails market leaders WhatsApp (450+ million MAUs), Facebook messenger and WeChat in terms of MAU's and its flattish user base could prove to be a negative.

QNX Software Has A Huge Installed Base, But Forward Value Capture Is Key

BlackBerry's sometimes overlooked QNX software business has been receiving quite a bit of buzz lately. Although BlackBerry bought QNX software systems to build its BB 10 operating system and power its Playbook line of tablets, the software is primarily used in embedded systems given its low hardware requirements, stability, and flexibility. The software has been particularly successful in the automobile infotainment market. Global automotive infotainment systems sales stood at close to 40 million units in 2013, and QNX had a market share of roughly 53%.

Not Very Meaningful To BlackBerry's Bottomline : However, despite its strong technical attributes and installed base, the QNX business is not believed to be very meaningful to BlackBerry's financial performance (the company does not break out QNX financials). The business generates revenues through the licensing of QNX software products (primarily operating systems and middleware) and through the professional services that BlackBerry provides to customers for developing QNX powered devices. Estimates from Bloomberg peg QNX revenues at just about 2% of BlackBerry's total sales and IHS analysts estimate software licensing fees at a relatively paltry $3 per vehicle. (BlackBerry Leads in Connected-Cars Market Google Covets, Bloomberg, March 2014)

Smart Homes, Automotive Safety Are Areas To Expand :  A bulk of the value in the automotive infotainment market comes from offering a differentiated user interface and user experience. This is an area controlled by OEMs and auto manufacturers. QNX's OS and middleware, on the other hand, operate behind the scenes, having a lower ability to capture end-consumer value.  This could prove to be an issue for BlackBerry if it wants to grow in the connected automotive market (which is forecast to touch $53 billion by the year 2018), since the share of core software sales as a percentage of the overall market size could decline as the space becomes more commoditized.

The QNX division has been looking at other avenues for growth as well.  The growing interest in the 'Internet of Things' such as smart homes could be an important area. QNX should have an early mover advantage in this space since it already has a large network of third-party developers and also intends to launch a cloud platform later this year. The company has also been looking to make a push into automotive safety, with its QNX OS for Automotive Safety 1.0 offering.

30% Upside To Price Estimate If User Base Stabilizes

BlackBerry's services offering accounts for close to two-thirds of the company's enterprise value, according to Trefis estimates. Our current $8.50 price estimate for the company assumes that the total BES subscriber base will decline at roughly 10% annually and stabilize at about 21 million users by the end of the Trefis forecast period (CY 2020), while average monthly subscription fees will decline to around $2.65 per month (including consumer and business users). We estimate that EBITDA margins for the service will improve to around 28% by 2020 due to lower fixed operating expenses. However, if the company is able to stem the decline and maintain subscriptions at levels of around 40 million users going forward, while realizing an average revenue per subscriber of around $3 per month, it would increase our price estimate by roughly 30% to about $11.25.

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A 30% Upside To Price Estimate If User Base Stabilizes: BlackBerry's services offering accounts for close to two-thirds of the company's enterprise value. Our current $8.50 price estimate for the company assumes that the total BES subscriber base will decline at roughly 10% annually and stabilize at about 21 million users by the end of the Trefis forecast period (CY 2020), while average monthly subscription fees will decline to around $2.65 per month (including consumer and business users). We estimate that EBITDA margins for the service will improve to around 28% by 2020 due to lower fixed operating expenses. However, if the company is able to stem the decline and maintain subscriptions at levels of around 40 million users going forward, while realizing an average revenue per subscriber of around $3 per month, it would increase our price estimate by roughly 30% to about $11.25.




The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: BBRY , MDM , APPL , SSNLF , GOOG

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