This Company Needs to Be More Innovative

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

Investors are always looking at the pipeline of companies in order to determine if their investment will bring capital appreciation. The cellular phone industry is a tough sector where technology is evolving at a rapid pace. Since Apple (NASDAQ: AAPL) released the iPhone, BlackBerry (NASDAQ: BBRY) and Nokia (NYSE: NOK) have lost significant market share. In an effort to regain some of the lost territory, BlackBerry developed its own operating system called BlackBerry 10.

Further, the company developed two devices called the Z10 and the Q10. However, according to the most recent quarterly earnings report, the BB Z10 was not received as it was expected. The question to discuss is: Is BlackBerry a good buy at these levels after dropping close to 30% in a week?

I fear the answer is no

Strong reasons suggest that investors avoid the stock until further notice. The number of units shipped came surprisingly short this quarter, even though its new model BlackBerry Z10 was expected to be a blockbuster.

In a previous article, I wrote about the disappointing sales of the BB Z10. The company invested many resources for the development of the new BlackBerry 10 operating system. Investors were excited, and it was the last hope for them. Sadly, only 1 million BB Z10s were sold in the first four weeks after release in the previous quarter.

The company sold 2.7 million units in 12 weeks, or 225,000 devices per week, compared to the 250,000/week in the previous quarter. I fear the demand for the devices is dimming. The number was well below several analysts’ estimations. Morgan Stanley’s Gelblum was expecting 3.5 million BB10 devices sold in the first quarter. Citigroup’s Jim Suva, who has a sell rating on the company and a $10 price target, expected shipments of 3.25 million.

Here is another concern: The company failed to disclose the number of BB Z10 units shipped in the original quarterly earnings report. I do not like when companies do not fully disclose information to investors. Think about how an investor would feel about Apple not disclosing how many iPhones were sold in the first or second quarter.

Another point that is of interest is the decline in subscribers, since 28% of the revenue is accounted for by the software and services areas. The number of subscribers fell from 76 million to 72 million. In the quarter preceding it (fourth quarter of 2013), subscribers fell from 79 million to 76 million. Overall, there is a steady decline in subscribers, which is not good for the company.

Finally, although the company’s revenue increased 15% on a year-over-year basis, the company swung to a net loss of $84 million, or $0.16. This was a surprise considering that the company had been profitable in the previous two quarters.

Why are subscribers going to other cellular phone makers?

More often than not, the simplest answer is the best one. The company had stopped innovating its products, and they were not bringing substantially new features. It was different in the mid-2000s when BlackBerry introduced the QWERTY-type keyboard. It was an important feature because it reduced the text-message typing times. However, most of the new cellular phones have a QWERTY keyboard implemented in the system.

There has been some speculation about several government agencies testing new BlackBerry 10 devices due to higher security features. Until an agreement is signed between these agencies and BlackBerry, it is pure speculation, and the investment should be regarded as such. I do not recommend investors jumping in just yet.

Even if BlackBerry manages to sign up a deal with government agencies, the base of its subscribers is still in the emerging markets. However, sales in Latin America are declining. What’s more is that I believe they will continue to decline. The reason is because the middle-class is rapidly increasing in many countries. A BlackBerry phone is popularly regarded as a device for the lower income group (I am from Mexico, and I lived there 18 years).

Nowadays, the population has higher disposable income, so they prefer to go with more popular brands such as the Apple iPhone or the Samsung Galaxy devices.

Overall, the company does not offer a good investment prospects, and investors should steer away from it.

With that being said…

Samsung and Apple are well established in the cellular phone market. BlackBerry and Nokia are competing for the third place. Although BlackBerry’s subscribers number declined, investors should not think that they are using Nokia devices.

Nokia has also failed to bring substantial innovation to the table. Granted, the 40-plus mega-pixel camera is a nice feature on a cellular phone, but most of the customers like us do not buy the devices to just take pictures. Instead, it has to offer great versatility.

The company is also losing market share in emerging markets, where it used to have a strong presence. The company has also failed to fully penetrate the market in China. Since the middle class is rising, less customers would be inclined towards Nokia.

There is one young lady who has come to my research laboratory (Chemistry, in a University of Texas school) who has an iPhone. According to her, one out of every three students at Beijing Normal University has an iPhone.

Although it may seem exaggerated, it is in concordance with statistics published by Nokia in the last quarter. According to the cellphone maker, the number of units shipped to China declined 63%. Revenue shrunk 21% to $5.8 billion. Also, the number of devices sold declined 21% to 55.8 million units. These metrics are not appealing to investors.

Overall, investors should look elsewhere when they make decisions regarding gaining exposure to the telecommunications industry.

So what to do?

I believe Apple may offer better investment prospects than Nokia and BlackBerry, although the stock has declined from $705 to $400 since September 2012. According to its most recent earnings report, net income rose 10% to $43 billion, or $10.09 per share. Also, iPhone sales rose to 37 million units, compared to 35 million units a year ago.

I believe the decline in Apple presents a great opportunity to grab some shares. The company trades with a P/E of 9.5. Further, the company pays a hefty 3% dividend that just got hiked. In addition, the company has authorized a massive share repurchase program worth $100 billion.

With a strong free cash flow, I have no doubt Apple will succeed in bringing capital appreciation to its investors. Its free cash flow increased 10% to $31 billion.

Conclusion

BlackBerry reported what I expected and others did not. The Z10 was not received by customers as it was expected, even though the company spend huge piles of cash to develop its BlackBerry OS. As a result, the stock lost 27% after the earnings release. Although the company plans to increase its advertisement of the Z10 through the rest of FY2014, I do not expect sales to increase. I think BlackBerry is not what it was once.

With that being said, I also expect Nokia to do poorly. Neither of the companies have brought innovation, and as a result, they have migrated to other companies such as Samsung and Apple.

I believe Apple offers the best investment prospect for investors who want to grab a piece of the telecommunications industry. The company trades at an appealing price-to-earnings ratio, its sales and net income are increasing as well as the number of devices shipped. Further, the company offers a nice dividend and it has initiated a massive share repurchase program. For these reasons, I recommend going long Apple, and avoid BlackBerry and Nokia.

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Robinson Roacho has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. 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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