BlackBerry Shorts Have Little To Gain, Much To Lose

| About: BlackBerry Ltd. (BBRY)

Analysts have been forecasting the demise of BlackBerry (NASDAQ:BBRY) (formerly RIMM) for over two years now. The Apple (NASDAQ:AAPL) iPhone, Samsung S III and other phones using the Google (NASDAQ:GOOG) Android operating system have captured a huge share of the market once dominated by the BlackBerry. However, much of the dramatic loss of market share has been offset by an explosive growth in the overall smartphone market. As a result, BlackBerry unit sales have not dropped significantly and the company still has 79,000,000 subscribers worldwide. The average selling price of a BlackBerry phone has dropped significantly as the company has expanded into developing markets where selling prices are lower, and has been shifting old inventory at discounted prices. In the last reported quarter, the average revenue per phone had dropped to less than $250, and gross margin was about $70 per phone.

At the end of January 2013, the company introduced its new operating system and a touch screen version of its new smartphone (Z10). This will be followed in April by a keyboard version (Q10). The keyboard is popular with many existing users. The Z10 is a high-end smartphone competing at a retail price level of about $800, similar to the iPhone and Samsung Galaxy S III. BBRY's revenue per phone will be about $550, and gross margin should be over $300.

The Z10 phone has met with excellent reviews, user opinions are overwhelmingly positive and in a recent customer satisfaction survey the phone scored higher than either of its major competitors. However, due to delays in testing by networks, the phone is not yet available in its main market (the USA), where 22% of existing BlackBerry subscribers are located.

Although no firm sales information has been released, it is apparent that sales have been strong in the markets where the phone has been released. Reports from the UK indicate sell-outs at many stores and many retailers have increased prices so as to improve profit margins as demand exceeds supply. In Canada, reports of sell-outs and waiting lists are common and the UAE was reported to have sold out within one week of launch.

BlackBerry CEO, Thorsten Heins, recently announced an increase in production.

BlackBerry has also resolved one of the primary complaints about previous BlackBerry phones, the lack of available apps. Not only does the phone come with over 70,000 available apps of its own, it also includes easy transportation of apps from the Android platform. With this feature, BlackBerry Z10 now has more available apps than any other phone on the market.

However, in spite of the very positive reviews, some analysts remain skeptical and have issued downgrades, including sales forecasts, which are unexpectedly low given the information being posted by customers and potential customers. Analysts are suggesting that the reported sell-outs are a result of short supplies rather than high sales. As of last January, approximately 30% of the outstanding stock of BBRY had been sold short, leading to speculation that analysts are trying to drive down the stock price to cover their short positions.

I have put together an analysis of the profitability and value of BBRY, under various scenarios, based on the following assumptions:

1. Z10 wholesale prices of $550 per unit

2. Z10 manufacturing costs of $154 per unit

3. Packaging and distribution costs of 70% of manufacturing costs

4. Revenue and costs from sales of older model BlackBerry phones assumed to be 50% of Q3 2012

5. Launch costs for the Z10 series of phones - $2 billion amortized over 4 quarters

6. Sales, general and admin costs $0.5 billion per quarter (no significant change from Q3 2012)

7. R&D costs $0.5 billion per quarter (25% increase from Q3 2012)

8. Services and software revenue down 20% (worst case), stay the same (likely case), up 20% (best case)

9. Services and software gross margin 50%

10. Worst case value = 3 x EBITDA, likely value = 5 x EBITDA, best case value = 6 x EBITDA

Worst case scenario

The most pessimistic forecast for BBRY sales is about 300,000 units for the first month of the Z10 launch.

The three countries where the BB10 has had a full month of sales account for 18% of BBRY worldwide subscribers. (Canada 4%, UK 11%, UAE 3%). Factor in a few days of sales from Germany, France and others, and Z10s will have been available to only 20% of existing subscribers during the month.

Projecting these sales to all countries, gives a number of 1.5 million units per month, or 4.5 million per quarter.

Likely scenario

BBRY has about 79,000,000 users worldwide. Approximately 60% of those users are located in countries, which have a high proportion of middle income earners, who can afford to pay $800 or more for a high-end smartphone.

Most BBRY users in developed countries have stayed with BBRY because of the security features and in some cases, the physical keyboard. Those users have stayed with BBRY during a period when products running iOS and Android have been superior. They are not likely to switch from BBRY now that BBRY has a product that is better than the competition.

Of the 40% of sales to developing countries, which generally include a small portion of high income earners and many low to middle income earners, the most likely scenario is that high income earners will choose the Z10 and low income earners will keep their old phones or wait for the lower priced models which BBRY intends to release later this year.

A reasonable assumption therefore is that about 60% of the 79,000,000 BBRY users will buy the Z10 over a period of three years (the average cell phone replacement life).

BBRY has released a statement, admittedly based on very early sales figures, that 40 to 45% of the sales have been to users of Apple and Android phones. Given that the Z10 sells for about the same price as the other high-end phones and is at least equal in features and quality, it is reasonable to assume that this statement is correct. However, to be conservative, let's assume that about 30% of the new sales are to users who are switching from other operating systems

Using these assumptions gives the following:

  • Sales to existing BlackBerry users per quarter 0.6*79,000,000/12 = 3.95 million
  • Sales to users switching from other smartphones = 1.62 million
  • Total Z10 and Q10 phones sold - 5.57 million

Best case scenario

This scenario is based on a survey done by Seeking Alpha member Michael Collins. He visited several retail outlets in the UK and asked about sales of BlackBerry versus other smartphones. Although the answers varied widely, a reasonable assumption would be that BlackBerry is set to capture about 25% of total smartphone sales in the UK

Figures released in November 2012 show BlackBerry had 6.5% of the UK smartphone market. If our assumptions are correct, the launch of Z10 has increased market share by a factor of 3.8.

During the quarter BlackBerry sold 6.9 million phones worldwide. Assuming the same rate of increase but only in developed countries (60% of the total), BlackBerry Z10 sales per quarter will be 3.8 x 0.6 x 6.9 million = 15.7 million phones per quarter.

A 3.8 times boost in market share in the USA would give BlackBerry slightly more than 5% of the market, which leaves plenty of room for even the "best case scenario" to be exceeded.





Quarterly Revenue

Z10 and Q10 sales (Units)




Z10 and Q10 income (millions)




Older phone models revenue




Services and software revenue




Total revenue (billions)




Quarterly expense

Z10 and Q10 costs




Older phone model costs




Services and software costs




Launch costs




Selling, general and admin costs




R & D costs




Total expense




EBITDA (quarterly)




EBITDA (annual)




Enterprise value




Share value

$ 10.68

$ 33.36

$ 178.11

Click to enlarge

The share price today is around $13.20.

Reasons to go long include:

  1. BBRY is in a very solid financial position - $2.9 billion cash and no debt. Cash flow from operations in the last reported quarter was $950,000. This is not a company, which is likely to go out of business any time soon.
  2. Comments from actual buyers and users of the Z10 are overwhelmingly positive. The product is clearly superior and sales will be strong.

  3. Lay-offs and cost-saving measures have trimmed the fat from the company and are projected to save about $1 billion per year in operating costs.
  4. Excess inventory of older, low margin phones was significantly reduced in the last quarter, profit margins should increase dramatically as Z10 phone sales replace the discounted sales of older models.
  5. A short squeeze is possible - with 30% of the outstanding float sold short, any upside news could cause panic among the shorts.
  6. There is potential for a takeover offer which could instantly boost the stock price by 50% or more.
  7. Sales of smartphones are forecast to increase by 17% per year. BBRY does not have to increase market share to remain profitable. In fact it can succeed with a reduced market share, provided it can stay at the high end of the market and maintain profit margins. Recent announcements of retail price increases in the UK indicate that the Z10 can be sold into the high-end market.

Shorting this stock is a very risky move, with little to gain and a lot to lose.

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.