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The popularity of Android has become a serious problem for competing mobile platforms. The only smartphone platform showing some resemblance of competition is Apple, but then again it relies mostly on hardware capabilities. Google’s (NASDAQ: GOOG) Android now accounts for nearly 75% of all smartphone devices. In this Android dominated space, Microsoft and BlackBerry (NASDAQ: BBRY) are trying to carve out a market for their platforms. The market has been keeping a close eye on the efforts of BlackBerry to make a comeback in this highly competitive smartphone industry.

Fundamentals

The quarterly earnings reports are a gold mine for investors looking for fundamental information. It is even more crucial for BlackBerry investors because it gives device sales data and expectations from the future. Therefore, it was no surprise when company valuations slid 30% following the disappointing results from the first quarter. The street was expecting it to post earnings of $0.07 per share on revenues of $3.38 billion. BlackBerry missed these targets miserably, posting revenues of $3.07 and EPS of -$0.10.

Lower than expected device sales were the primary culprit behind the ‘miss.’ The street was expecting shipments of 7.3 million, but they missed the target by 7% and reported 6.8 million shipments. A decline in shipments is normal during the transition to a new platform, but surprisingly even the new BB10 devices came below expectations. The street was expecting BB10 device shipments to be around the 3.3 million mark. BlackBerry only managed to ship out 2.7 million devices.

The Good

Missing the market expectations was a massive setback for BlackBerry but at least the company managed to show 9% top line improvement year over year. While the recovery might be slower than the market anticipated, it is still there. The cost cutting measures and premium BB10 pricing are reflected in the improving gross margins. Gross margins improved to 33.9% as compared to 32.8% in 2012. The company is also in no immediate financial crisis. It generated approximately $630 million from operation cash flows and increased its cash pile to $3.1 billion from $2.9 billion in the previous quarter. In a positive strategic move, BlackBerry is now trying to target the high growth Asian and South American markets with the medium-low end devices. The company launched its latest Q5 devices for this purpose.

The Bad

The biggest disappointment from the quarter was the low sales of BB10 devices. The company managed only 2.7 million shipments for its new flagship phones which are probably its last chance for a comeback. The devices were not able to garner consumer interest. The U.S. launch was delayed, so the North American impact was limited.

A strong BlackBerry subscriber base has always been an argument for an investment in BlackBerry. Unlike companies like Nokia, which rely only on device revenues, service revenues from BlackBerry have always been a key factor behind the buy argument for BlackBerry. This strong subscriber base limits the downside because it is a constant source of operating cash flows from services. The shrinking of subscriber’s base to 72 million from 76 million is another sign of concern. The street was also expecting a decline but only of around 2 million.

While targeting the mid and low range markets is a positive step, the company is going the wrong way about it. The Asia and South American markets focus highly on value. The primary method of estimating this value is through hardware feature. BlackBerry is selling (Dual-core, 8 GB and 5MP camera) Q5 for around $400-$500 (Unlocked) when the consumers can buy Samsung’s (NASDAQOTH: SSNLF) S3 for almost the same price. The latter has a quad-core processor, 8MP and 16GB memory. If the company is serious about targeting this market, it will have to reduce the price and compete on hardware capability with Android devices.

Android Sales

Google’s Android is going strong, but its largest manufacturer has run into some trouble. Samsung valuations are down almost 5% since the company released its June quarter results. The street was expecting Samsung to post earnings of 10 trillion-won but it managed only 9.5 trillion-won. The company reported 74 million smartphone shipments, as opposed to expectations of 76 million. The S4 managed much lower shipments than the company hoped. It faced competition not only from other Android devices but also Samsung’s own S4 mini; mini has lower margins. More than anything, the slide is due to market paranoia that giant such as Samsung are also being affected by cheaper alternatives, are forced to roll out cheaper versions of their flagship phones and compromise on margins. Going forward the street should expect margins to slip in the smartphone industry, but that should not have an impact on Android.

Way Forward

This quarter suggests that comeback in the smartphone industry will not as easy as BlackBerry investors hoped. While the BB10 devices have excellent hardware and some exciting features, the competition is also coming up with new hardware and devices. Samsung’s Android loaded S4 has attracted a lot of consumer attraction and is currently the highlight of the smartphone sector. The company has also launched a mini version of its S4 devices. The shares of Samsung have declined, primarily due to missing high market expectations. If BlackBerry plans to compete with Samsung, Nokia and Sony in the emerging markets it will have to compete on price and hardware capability.

 The only way forward is to lower its margins and focus on building itself as a high margin service based company. Offering different packages of its BlackBerry services in the emerging markets will be a step in the right direction. The company is also willing to license its BB10, but it’s too soon to tell if leading manufacturers will be willing to move away from Android.

Bottom-line

The current quarter was a serious setback from BlackBerry, but the company is still in the competition. Despite missing analyst expectations, BlackBerry’s financial health is still pretty good. The biggest concerns are the shrinking of subscriber base and low BB10 unit shipments. The company has made the right strategic move by focusing on low/medium-end markets but is going the wrong way about it. It should be focusing on competing on price and hardware capability. The main order of business should be stemming the flow of its subscriber base deterioration. Current investors should hold on while new investors should avoid BlackBerry shares until BB10 gains some traction. 

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Mohsin Saeed has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google. 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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