MT Insider: Blackberry Slides on Negative Q2 Outlook, Sum of the Parts Analysis Suggests Valuation Of Less than $6 Per Share

It is no secret that BlackBerry (BBRY, BB.TO) is facing a number of challenges given continual subscriber losses as the company battles increased competition from next generation Apple ( AAPL ) and Google ( GOOG ) smart phone devices. Microsoft ( MSFT ) also is throwing its hat into the ring with the acquisition of Nokia's ( NOK ) services and devices business.

Prior to the market close on Friday, BlackBerry ( BBRY ) shares were halted and closed down 17% at $8.72. The company issued a press release shortly after the halt announcing preliminary Q2 results, and they didn't look pretty. This morning, the stock continues to decline, shedding another 6% in Monday's pre-market trade.

The company is expecting a GAAP (Generally Accepted Accounting Principles) net operating loss of $950 million - $995 million (including inventory and restructuring provisions), which is significantly lower than the Thomson Reuters consensus estimate for an operating loss of $191 million.

Revenues for Q2 are expected to be $1.6 billion, which is about half of what consensus was expecting at $3 billion. Putting this into perspective (and in an ironic twist), Blackberry picked Friday to let investors know that the company sold just 3.7 million smart phones in Q2.

Additionally, the devices sold in Q2 were still Blackberry 7 devices versus the newest version launched, Blackberry 10. This compares to Apple ( AAPL ), which launched the iPhone 5C and 5S on Friday with expectations of 6 million units to be sold over the weekend, 60% more units than BBRY sold in an entire quarter.

According to the release, the company will "refocus on enterprise and prosumer market, offering end-to-end solutions." By definition, "prosumer" is a combination of the professional and consumer client, and represents those entrepreneurs who influence markets through social media.

Blackberry is also rationalizing its product line down to 4 devices, and the company will "re-tier the BlackBerry Z10." Following in the footsteps of its peers, this likely means offering versions at different prices to reach a broader audience. That said, it is likely too late to switch strategies at this point.

Moreover, BBRY "sees increasing penetration of BlackBerry Enterprise Service 10 with more than 25,000 commercial and test servers..." This seems aggressive, and it is worth noting that the release uses the word "test." This suggests that contracts have not actually closed.

Recall back on 8/30 when Morgan Stanley (MS) noted that it would likely not be upgrading its users to Blackberry 10. This is a very rational decision given that the viability of BlackBerry is in question (and thus, MS cannot risk the possibility that the company will be unable to service any issues with the BB10).

Ironically, the company's dependence on the Blackberry 10 might have also led to its demise owing to a lack of diversification across product categories.

According to Alliance Bernstein, "we saw material evidence that Blackberry 10 is gaining very limited traction with users, be it consumers or enterprises: slowing sell-through numbers, sell-in well below expectations, 4M net users lost, and little indication of a broad migration of Enterprise clients."

Separately, the company announced a restructuring plan, which would slash the company's work force by 4500 jobs and would cut capital expenditures (capex) by 50% for fiscal Q1 2015.

This makes sense, as the company needs to address the company's cash cushion, which will inevitably dwindle over time. Cash is being used for production, and if inventory does not sell, write-downs will likely follow, further pressuring the company's asset value.

Taking a step back, a quick sum of the parts analysis by MT Newswires from August 30 gave investors an idea of what Blackberry's downside could be (using a 50% write down for the company's assets).

Assuming $2 billion in patents and $2.6 billion in cash (given in the release) and $1.7 billion in receivables and inventory (including a 50% write-down), less $3.4 billion in overall liabilities (including accounts payable and accrued expenses), suggests a total value of just $2.9 billion. Dividing this by 525 million shares outstanding, BBRY is worth less than $6.00 per share.

In the release late Friday, the company reiterated that the "Special Committee of the Board continues to evaluate strategic alternatives." Put simply, it means there has not been a "white knight" interested in the company - even for its patents - since it has been rumored to be up for sale for quite some time now, and the company still has yet to be scooped up.

On August 12, Prem Watsa, Chairman and CEO of Fairfax Financial, also BlackBerry's largest shareholder, stepped down from the Board of Directors due to a potential conflict of interest. This sparked speculation of a possible buyout by Watsa. Although this was highlighted by media/press reports as an incremental positive, as far as investors can ascertain, Watsa has reached out to pension plans in Canada, but there have been no bids to date.

The company has been on the block as a takeover target for over 2 years, although it was not openly acknowledged in writing until August 12. Since the rumors came to light, no realistic buyers have stepped forward so it is not a stretch to assume that interest in the company has been abysmal.

In an acquisition scenario, CEO Heins' departing compensation package is also worth pointing out, as it is seen by analysts as not in line with shareholder interests. His severance starts at $20 million upon a buyout, based on the company's proxy filing in May. Critically, the severance is not based on shareholder performance.

Separately, there has also been speculation that the company will go private, but this is also unlikely. In a leveraged buyout (LBO), private equity investors use debt (usually low investment grade) to purchase the company, and the assets of said company are used as collateral.

Because debt used is usually low investment grade (or even junk), interest rates are much steeper. In BBRY's case, going private is not a viable alternative as projections for operating cash flows are not high enough to support the uptick in interest expenses.

According to Goldman Sachs, assuming EBITDA margins stay flat (which are still lofty), the company would need to generate a 5-year revenue CAGR (compound annual growth rate) of 12% to generate an internal rate of return (IRR) of 10% - the usual threshold for private equity investors.

Owing to Blackberry's share losses in the smartphone market, analysts are currently projecting a long-term revenue loss rate of 6%, per Thomson Reuters, and this doesn't even include the negative pre-announcement on Friday.

And so the question arises - what happened? In October 2007, Blackberry had 10 million subscribers and was the leading smartphone in the enterprise and business market (Steve Jobs had already unveiled the iPhone earlier that year in January, at first targeting consumers).

At that point in time, the company made a crucial error in judgment. Apple could have the consumer market, and the iPhone wasn't a threat. In the company's defense, there were still loyal Blackberry users who liked its keyboard and blackberry messaging features (BBM).

In August 2007, shares in the Canadian maker of BlackBerry smartphones peaked at $236, and the firm was coined as the "most valuable company in Canada by market capitalization."

The company introduced new products, such as the Bold, to compete with the iPhone. It also had a touch screen, which is the exact opposite of what loyal users wanted (with most sticking with the Curve, as it still had a keyboard).

In short, it has been a steep fall from grace from the time BBRY held its dominant share in the smartphone market.

Again, perhaps the only option left is to file for bankruptcy.

In after hours trading on Friday:

BBRY 8.50 -0.23 -2.12

BB.TO 9.08 -1.74 -16.08

AAPL 466.45 -0.96 -0.21

GOOG 901.56 -1.55 -0.17

MSFT 32.76 -0.03 -0.09

MS 28.17 -0.02 -0.07

NOK 6.57 -0.01 -0.15

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

Copyright (C) 2016 All rights reserved. Unauthorized reproduction is strictly prohibited.

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

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