Why I Maintain My $39 Price Target On BlackBerry

Feb.25.13 | About: BlackBerry Ltd. (BBRY)

There isn't a stock that divides the market quite like BlackBerry (NASDAQ:BBRY) does. Investors are either incredibly bullish or incredibly bearish about the stock, there doesn't seem to be anybody without an opinion.

Essentially, the fortunes of BlackBerry are directly tied to the success of its new suite of smartphones, running the BlackBerry 10 operating system. Yes, the company has other divisions - namely, its QNX vehicle software - but these other divisions remain a fraction of the size of the handset division. BlackBerry is a handset story.

So just how many handsets will the company sell? It introduced the new Z10 model at the end of January, and it has been selling in Canada, Europe and many emerging markets since early February. The company did disclose that its opening weekend was a success, as it sold more than 3 times more handsets than any other opening weekend in the U.K. and 150% higher than any other opening weekend in Canada.

But that was 3 weeks ago, and the company has been mum since. Analysts have been vocal though, as Michael Walkley from Canaccord Capital cut his first quarter sales target from 2 million units to a mere 300,000. BlackBerry shares sold off sharply on this news. Walkley maintained his $9.00 price target on the stock.

So why, given disappointing analyst projections, am I bullish on the stock? Let's start with overall smartphone market growth. World smartphone penetration passed the 1 billion unit mark back in the third quarter of 2012, and is predicted to surpass 2 billion by 2015. If BlackBerry can capture just 2% of the market in 2013 - estimated at 1.4 billion units - then the company will sell 28 million handsets. Is that overly ambitious? Maybe, but the point is the smartphone market is huge, and there's room for more than 2 players.

Also, the Q10 model (with the QWERTY keyboard) will be released in the spring, just in time for the U.S. carriers to carry it. I understand why the company released the Z10 first, since it's the closest thing BlackBerry has to a potential iPhone killer, but one of the main things consumers love about its BlackBerry is the physical keyboard. Demand for the Q10 should be strong, as BlackBerry users are attached to its physical keyboards.

Margins are also attractive. Estimates put the cost to manufacture the Z10 at $154. Currently, in Canada, the phone is selling for $649 (without a 3 year contract) or $149 with a 3 year contract. Let's look at some revenue and gross profit projections, based on number of units sold:

Units Revenue Gross
2M $1.3B $990M
5M $3.25B $2.48B
7.5M $4.87B $3.71B
10M $6.49B $4.95B
15M $9.74B $7.43B
20M $12.98B $9.90B
Click to enlarge

If the company manages to sell 15 million units in 2013, (not so difficult, considering over 2 million alone could come from Canada) this puts gross margins at $7.43B. Yes, the company is spending a lot on marketing the new devices, but it also aggressively cut costs during the second half of 2012, and it won't have excessive R&D expenses like it did during the latter half of 2012. During the glory years of 2008-2011, the company averaged net margins of 16.9%. If you estimate a conservative net margin of 10%, that's $974M in profit, or $1.85 per share.

At $1.85 per share in profit, a $39 price would mean BlackBerry would be trading at a little over 21x earnings, not an unreasonable multiple for a company with growing momentum, a solid balance sheet, and devices the consumer is proud to show off to their friends. It should continue to show improving sales traditionally stronger markets like Europe, the middle east, and Canada, and even moderate success in the U.S. will propel this stock higher.

Disclosure: I am long BBRY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.