Has BlackBerry Re-Entered Its Death Spiral?

Mohammed is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

What a disaster! These were the exact words that crossed my mind as I first saw the results of BlackBerry's (NASDAQ: BBRY) Q1 FY 2014 earnings. I truly believed that BlackBerry would be in the black this quarter and that it would significantly beat consensus estimates. There was a lot of upbeat optimism among analysts over the past few weeks. RBC Capital predicted 3.5 million BB10 shipments and an EPS of $0.09. Scotia Bank predicted sales of 5.5 million BB10s and an EPS of $0.72. There were also bullish sentiments from Morgan Stanley, Goldman Sachs, and Raymond James, among others. But, actual results were ugly.

A miss here, a miss there

BlackBerry under-performed in almost every metric imaginable. BB10 shipments came in at approximately 2.7 million units, below consensus estimate of 3 million-3.5 million units. Service revenue fell 16%, sequentially, from last quarter versus a 3% sequential decline last quarter. Subscribers fell by 4 million versus a 3 million drop last quarter. Gross margin fell to 33.9% versus 40.1% last quarter. This happened even though management assured us on the last earnings call that the company will maintain a strong gross margin this quarter. Top line revenue came in lower than expected at $3.1 billion versus $3.36 billion, and EPS missed consensus estimates by $0.18, coming in at -$0.13. 

The company wasn't able to realize $72 million in service revenue due to Venezuelan currency restrictions, but even if that revenue had been realized, the company would have still missed estimates and generated a loss.

There were a few bright spots in an otherwise very bleak quarter. Revenue increased in three out of four regions, most notably in North America. Operating cash flow came in at $630 million, and BlackBerry was able to increase its cash position by $200 million, bringing the balance sheets to $3.1 billion. Positive cash flow is attributed to the receipt of $564 million in R&D tax refunds from Canada's Scientific Research & Experimental Development program. This program allows BlackBerry to receive back approximately 20% of every dollar spent on R&D, and may prove to be a valuable tax asset going forward.

Market share slips

In May, IDC released data for the first quarter of 2013 that showed BlackBerry's worldwide market share slipped behind Microsoft's (NASDAQ: MSFT) Windows Mobile, which is now in third place. Windows Mobile, championed by Nokia, has grown by 133% year-over-year to 3.2%. That's not much, but it represents growth, unlike BlackBerry's market share, which declined to 2.9% from 6.4%.

The difference between the two platforms in the U.S. market was even more pronounced. For the three months ending April 2013, Windows Mobile market share has grown from 3.8% to 5.6%, while BlackBerry's market share slipped to 0.7% from 5.3% a year earlier. This data includes the period in which the Z10 was launched and shows that BlackBerry has, so far, failed to make any type of comeback in the U.S. with the BB10.

Death after arrival?

Last year, many pundits said that the BB10 was likely to be dead on arrival (DOA) once it hit the market. Last quarter, BlackBerry fans criticized the shortsightedness of these pundits and pointed out that their DOA predictions hadn't been true, and that the BB10 was starting to pick up steam.

However, it just may be that the Z10, BlackBerry's flagship touch-screen device, is likely to die out, though not as soon as critics expected. Thorsten Heins announced during the earnings call that the company will no longer upgrade the Playbook to BB10. This seems a gentle way of implying the company plans to kill the product. The Z10 may eventually suffer the same fate.

There are many indications that demand for the Z10 fell off a cliff this quarter including:

  • BlackBerry shipped just 2.7 million BB10s last quarter, versus 1 million last February; this is already lower by 100,000 per month.
  • Last quarter, BB10 became available in 72 countries, versus just Canada, the UK, and the UAE, yet the company shipped less per month.
  • This quarter also featured a significant number of Q10 Shipments, therefore, Z10 shipments are even less than 2.7 million.
  • Last February, management stated that approximately 70% of shipments had sold-through, yet refused to say anything about sell-through of BB10 units this quarter. This suggests poor performance.

The Z10 doesn't appear to be selling quite as well as fans had hoped. We'll see if the company has better luck with the Q10 next quarter.

Hey, we're not Apple

If you were to compare the Q4 earnings call to the most recent one, you would find that the former was mostly about the new BB10 device roll-out, how upbeat management was about it, and how the company has been able to turn itself around with this new platform. This quarter, while listening to the call, you get the impression that management is downplaying the immediate transformative impact of the BB10 release. 

Thorsten Heins stated: 

"We've never been a device-only company; as we are also running a global secure data network and services business. And we don’t plan to run the company with a short term device-only strategy. What is exciting about BlackBerry today is that we are getting very comfortable with who we are as a company, and where we will fit in the market."

There was more talk this quarter, although obscure, about things like Secure Work Space, BBM Channels, and BES 10. Management also stressed on how competitive the smartphone market is. It seems that the company has realized that it's going to be much more difficult to gain the market share that was lost.

mentioned before that, if BlackBerry is able to sell a lot of devices at a high average selling price similar to Apple and Samsung, then the decline of its service revenue won't matter. However, it seems that BlackBerry wasn't able to pull that off.  

The leadership positions of Apple's iOS and Google's Android look safer than ever from any challenge from BlackBerry. On the other hand, Nokia is making progress with its Windows-powered Lumia phones. Last year, Windows Mobile was the fastest-growing mobile OS in the world. The Nokia-Microsoft duo now looks likely to take third place in the smartphone wars.  

Going forward 

BlackBerry has a lot of headwinds to face. The company has been unable to created demand for its BB10 phones. Z10 demand has dropped like a rock, and the Q10 release didn't have a tremendous effect last quarter. Moreover, the company's service revenue, which was keeping the company cash-flow-positive through its crises, looks to be shrinking, which increases uncertainty.  

Wedge Partners Principal, Brian Blair, believes that the future of BlackBerry will be in selling low-end smartphones to consumers in emerging markets. The company is releasing the Q5 to address that market. However, Nokia already has a head start with its Asha phones, and the margins on the Q5 might not be that attractive and may not be able to offset the decline of BlackBerry's other products and services. Management has refused to speak in depth about new services like BES 10, so I don't know what to make of it yet.

Conclusion

I was bullish on BlackBerry, but after the results and, especially, the earnings call, I turned into a bear. I believe, if there will be a third eco-system that can challenge iOS or Android, it will most likely be Windows Mobile. BlackBerry may prove me wrong, but the company will need to pick up the pace over the next few quarters. 

I wouldn't suggest that you invest in BlackBerry for a turnaround or acquisition. There might be a buying opportunity, however, if the stock falls just north of its cash-per-share value of $5.90. If you are a BlackBerry shareholder and don't want to sell, I suggest that you take advantage of high option premiums by considering out-of-the-money covered calls

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Mohammed Shaaban has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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