BlackBerry – The Future Is Now

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BlackBerry CEO John Chen

I have been a BlackBerry (BBRY) bull for some time now. Critics have predicted the company’s demise due to the run off of SAF revenue and its flailing handset operations. CEO John Chen vowed to make software and services the future of the company, and the future is here.

The Future Is Now

My concern over the run off of SAF and a lack of cash flow to offset it caused me to sour on the stock. In FQ2 2018 SAF run-off still overshadowed any increase in software and services revenue. SAF was $37 million this quarter, a decline of $54 million, while revenue from software and services rose $40 million.

Total revenue was off 29%. SAF was down 39%, software and services was flat and handheld devices fell 85%. Handheld devices includes the sale of BlackBerry’s remaining inventory of legacy smartphones and smartphone accessories. BlackBerry has transitioned from outsourcing the manufacturing of handheld devices to developing and licensing its secure technology. Revenues in this segment could continue to decline as inventory of the the company’s own handheld devices will not be replaced. However, profitability could improve as BlackBerry was losing money in the handset business, and tying up millions in capital.

What gives me pause is that flat software and services revenue growth benefited from a  one-off event. Licensing, IP and other revenue increased 250% from $16 million to $56 million. BlackBerry met a revenue recognition criteria during the quarter for a previously signed intellectual property licensing agreement, which drove the increase. Otherwise, software and services total revenue would have been flat and BlackBerry’s total revenue would have fallen by 40% Y/Y.

BlackBerry expects revenue from licensing, IP and other revenues to be about $100 million for FY 2018. It was $88 million for the first two quarters, which implies it could generate $12 million for the rest of the year. The fall off in revenue from this segment could cause total FY 2018 revenue to be a disappointment.

BlackBerry Is More Profitable Now

I always felt that BlackBerry would be better off in the handset business. It would give the company another potential catalyst outside of software and services. However, the company could not make an acceptable return on its investment. It tried to go it alone. Then it tried outsourcing its handset manufacturing in order improve its margins. When that did not work the company scrapped handsets altogether. It is now able to forego the losses from handsets. In FQ2 2017 the company reported an $8 million operating loss on $105 million in handset sales (prior to corporate allocations).

This quarter BlackBerry’s total gross margin improved to 74% from 29% in the year earlier period. EBITDA actually increased 11% Y/Y to $50 million despite the decline in revenue. Going it alone in software and services is a scary thought. However, by exiting handsets BBRY bulls no longer have to worry about how much cash the company will bleed each quarter. That’s a good thing.

BlackBerry Has Over $2 billion Of Dry Powder

Over the years John Chen has held BlackBerry’s financials together as best he could. He cut costs to help improve margins. He also managed working capital to help stem cash burn. The company’s recent $940 million arbitration award from Qualcomm (QCOM) for certain royalties due the company, interest and attorneys’ fees also helped matters. BlackBerry now has cash and equivalents of $2.4 billion versus $1.3 billion at year-end. Its working capital also increased by over $1.0 billion since year-end.

BBRY bulls no longer have to worry about BlackBerry running out of cash. The company now has dry powder to fund acquisitions or the next growth business. Its acquisition of Good Technology increased scale in enterprise mobility management (“EMM”) and could ultimately be a game changer. I believe BlackBerry needs another growth catalyst to help diversify away from EMM. Either the company can develop the technology or buy it. With financial markets reaching record highs each week an acquisition could be too costly. Its $2.4 billion in dry powder offers BlackBerry the flexibility to wait 18 – 24 months for markets to turn down and seek other bolt on acquisitions.

Conclusion

I expect BlackBerry’s revenue to continue to slide going forward, yet the company should remain profitable. I rate the company a hold until it can find acquisitions at an attractive price. That might take a year to two.

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