- BlackBerry stock jumped 5% after the company reported a beat on earnings, and the move to a royalty model in the handset business.
- New hardware strategy will save millions in inventory write-downs and other expenses. Margins are likely to improve in FY 2018.
- BlackBerry needs to improve its revenue to complete a successful turnaround. While the risk is coming down, the stock still carries a higher than average risk.
BlackBerry (NASDAQ:BBRY) stock jumped 5% on Wednesday (but gave back all the gains on Thursday) as the Waterloo, Ontario-based company reported a beat on earnings and made the much-awaited announcement of the discontinuation of its handset business. BlackBerry has signed an agreement with an Indonesian company to license its brand and software and take a fixed royalty payment. This strategy will reduce balance sheet risk for BlackBerry. As I had pointed out in my earnings preview, many investors and analysts wanted BlackBerry to dump the iconic handset business, as it was proving a big drag on earnings. So is BlackBerry finally on the cusp of a turnaround?
BlackBerry had a fairly decent quarter by its usual standards. The company reported a beat on EPS (non-GAAP) by 5 cents with the EPS coming in at $0 against the analysts' expectation of an EPS of -$0.05. The company remains to be a loss making one on GAAP basis, with the GAAP EPS coming in at -$0.71. On the plus side, the company reported its highest ever gross margin at 62% and expects it to remain above 50% in coming quarters. The margins are likely to improve in next fiscal year with BlackBerry discontinuing its handset business and restructuring its debt. Debt restructuring will have a positive impact of $0.025 on EPS every quarter.
Revenue continues to remain a big problem. Q2 revenues came in at $334 million, against an estimate of $393.75 million, a heavy miss by any standard. The revenue number represents a heavy 32% YoY decline. And this has also been the case in earlier quarters, with the company reporting a beat on earnings and a miss on revenues. If the company really wants a turnaround then it should get its act together on the revenue front.
The good part about revenue was the software segment, which grew by 89% YoY. But this big jump was largely due to the base effect. Software revenue in Q2 was lower than in Q1. But still, growing software revenues show that the turnaround strategy is working, at least in parts. And more importantly, around 81% of software revenues were of recurring nature, a bit higher than the year-end target of 80%. This is definitely a good sign. To quote John Chen from Q2 earnings call:
"Coming out of Q2, I feel that we are reaching in a good inflection point where our financial picture is stable and our pivot to software taking hold. In line with this pivot, we are announcing a new strategic direction in our mobility solution business, focused on developing and licensing of our security device software, as well as the BlackBerry brand."
The Indonesia Strategy
During Q4 2016 earnings, John Chen has announced a September deadline for its hardware business, which has been losing millions of dollars for BlackBerry. And yesterday, during the earnings call, BlackBerry announced that it will no longer be manufacturing handsets, and instead has entered into a partnership with an Indonesian JV to licence out brand and software on a fixed royalty basis. In a blog, Ralph Puni, COO BlackBerry has this to say:
"Today we make our first significant step toward leading as a software company by announcing that we are transitioning from doing internal handset hardware development to leveraging our third party partner to provide that function. This is what the future looks like for our business, and it is the right move as we progress towards profitability. "
The licensing agreement is with a new joint venture called BB Merah Putih. Under the agreement, the JV will source, distribute and market BlackBerry handsets in Indonesia. The joint venture is led by PT Tiphone, an affiliate of Telkomsel, which is the largest carrier in Indonesia, and Merah Putih and its affiliates.
And indeed the outsourcing of the hardware will save millions for Blackberry as it will no more take million dollar hits from inventory write-downs. The need for working capital will reduce and so will its selling and marketing expenses. As Mr. Chen pointed out "It's a long list of savings,". In this quarter alone, BlackBerry had to take a $96 million hit with inventory write-downs, which had a $0.18 impact on its GAAP EPS. And this had been the story every quarter.
The choice of Indonesia is a good strategic move. Afterall Indonesia has one of BlackBerry's largest and most loyal customer bases. According to a report by the Wall Street Journal, BBM is by far the largest messaging app used in Indonesia, much higher than WhatsApp. BBM had over 55 million users compared to 50 million on WhattsApp. Ralph Puni called the Indonesia strategy a "natural fit" stating:
"It is fitting that Indonesia is the first market where we are licensing our device software, as the country is historically BlackBerry's largest market for devices and, by far, the most substantial for the BBM messaging software we created."
A Turnaround Round The Corner?
It has been a couple of years since investors have been waiting for a turnaround in BlackBerry. And while some have held faith in John Chen and his strategy, many have been disappointed. With BlackBerry discontinuing its handset business, and software and service revenues continuing to show good traction, BlackBerry has moved closer to Mr. Chen's vision of a software company. But a turnaround still looks far.
While software revenues have been growing, the overall revenue continues to decline at a frantic pace. The handset division which forms a major chunk of overall revenues has been on a downward spiral, and with BlackBerry deciding to discontinue the handset division, the spiral is will likely to continue in the coming quarters. The success of the outsourcing model is still in question.
While BlackBerry has made significant moves in connected cars and fleet management, it is still too early to gauge their revenue generating potential. Will they be able to fill in the gap left by hardware division which still contributes more than a fourth of BlackBerry's revenues? And the fact that there was no revenue from IP licensing is another source of worry.
BlackBerry moved even closer to becoming a software solutions company by dumping its handset business. The move will definitely help its margins in the long run, but the revenue question still remains. Software revenues showed strong growth and about 81% of the software revenues are of recurring nature. BlackBerry has made significant strides in finding new streams with fleet management and connected cars but they are still in a nascent stage. The road to the turnaround is in sight but is still far with bumps ahead. While the risks have been declining, BlackBerry stock still remains a risky bet. The stock is only for long term deep-pocketed risk-taking investors.