I continue to be amazed at the amount of people who are so certain that BlackBerry (BBRY) will fail that they are willing to short this stock given its risk vs. reward profile. For full disclosure: I am one of the many ex-BlackBerry users who has tried both an iPhone and a Samsung (SSNLF.PK) Galaxy S3.
In my opinion, the type of company that makes a great short is one in a market that is in secular decline, has a ton of debt, and is bleeding cash. None of those characteristics relate at all to BlackBerry. You simply have a company that was riding the gravy train for far too long and was admittedly slow to react to the competitive forces in iOS and Android rising up around it. Even while completely getting outgunned by the competition BlackBerry continued to grow its subscriber base and amassed a balance sheet that has now given it the flexibility to buy time and reinvent itself. With that being said I have a 3-part thesis really meant to point out why I think shorting this company is an unnecessary risk.
Reality Point 1 - BlackBerry is not Palm
I think a fair number of those shorting this stock assume that BlackBerry is simply going to go the way of Palm. Here are a few stats to arm yourself with if you hear that argument and would like to provide a rebuttal:
- Palm installed user base ... negligible. BlackBerry user base ... ~80M
- Palm cash net of debt at the time it was acquired by HP (HPQ) - $200M. BlackBerry cash (no debt) as of December 2012 - $2.9B
- Palm unit sales in the quarter prior to being sold (AFTER launching its company saving product) - 960,000 units. BlackBerry unit sales in the quarter ended December 2012 - 6.9M units (BEFORE launching its company saving product).
- Palm operating cash flow in the 9 months prior to being sold - Negative. BlackBerry operating cash in the quarter ended December 2012 - $2.0B (while restructuring, developing a completely new phone and operating system, and selling completely outdated products)
This entire point could really go on and on. But to sum it all up, you have a company that is essentially failing and will go out of business within 12 months in Palm. That company is bought for about $1.4B because of their supposed assets (not of the tangible nature either). The question this leads to is do you really think BlackBerry at the market cap it has today is not worth about 5 times Palm was when it was sold?
Reality Point 2 - The Balance Sheet is Scary (but only for Shorts)
One of the things I really enjoy about financial statements is that assuming you are not dealing with Enron, Worldcom, or a company without an auditor you can generally trust that the balance sheet is stated factually. I will steer clear of the more easily debated analysis and not debate the value of the patents, property and equipment, brand, etc. ... associated with BlackBerry. For this purpose we will just assume that $5.5B or $10 per share in property and intangible assets stated on the balance sheet are worth nothing (even though this great accounting regulation called the impairment test forces the company each quarter to justify these values are recoverable). So we will focus on the less debatable portion of the balance sheet, which I have condensed for you below from the quarter that ended in December 2012 for BlackBerry:
What you can see is that if you were to liquidate the company today there remains $6.28 in tangible assets, or cash if you will, after paying off all liabilities. I even discounted certain assets where some might argue that in a liquidation scenario it would not be recovered dollar for dollar. Some might argue that inventory is not worth $457M as the analysts say it is selling its BlackBerry 7 product at a loss. I would simply provide a rebuttal to that by pointing you to its latest financial statements in Note 4 that show the inventory balance is net of a $477M reserve/write-down. So this inventory has already been written down to a point where it can be sold in the future at or above its carrying cost.
The next argument that I continually see is that six months from now this balance sheet will look completely different and will be bleeding cash. I do think that I also heard that argument months ago before the company actually increased its cash balance by $900M. But in light of still hearing that argument my next point seeks to paint an example of why you should not be so sure about the company's financial position eroding in the future.
Reality Point 3 - The Cash Flow Machine Is Still Primed and Ready
In thinking about how to make this point I have struggled with finding a simple enough explanation. Clearly assumptions have to be made about the future operating performance of the business. So I have tried to take the facts we know about the company's cost structure, estimates of changes to the service revenues, and analyst estimates of future BlackBerry Z10 sales to illustrate future cash generating power. So here is a simplified version of a statement of cash flow showing what the rough cash needs were for BlackBerry over the last 9 months:
So why is this $2.7B number important? The reason it is important is because as of the last quarter BlackBerry had a 9 month run rate of about $3B from its service revenues (software/other included). All analysts are for the most part in agreement that this is at least an 80% gross margin business. So assuming an 80% gross margin on this business the company is generating $2.4B of the $2.7B in cash they need to maintain their cash position as it stands today.
So let's quickly annualize that $2.7B cash outlay number and say over twelve months BlackBerry will spend $3.6B and that its gross margin from service and software revenue is $3.2B. Hold onto those numbers in your mind as they will be an important part of the following thesis.
The company has announced that its service revenues will decline with the way that the new phones will utilize its network architecture. It doesn't know how quickly this decline will happen and what level these revenues will stabilize at. Some analysts assume draconian levels of decline as soon as the new phones are launched. Some are much more measured in their estimates of how long the company will actually still generate meaningful revenue and cash flow from this business segment.
Let's assume that next year the $3.2B in cash I referenced above from service revenues is cut in half to $1.6B (note that I have seen no analysts calling for this to happen). Now let's assume this analyst from Cannacord who has a $9 price target on the stock is correct and that next year the company sells 13.9M Z10 phones. We can make a pretty good guess that BlackBerry is selling the phones to carriers for about $500. This is based off the fact that since launching the new phones the carriers are selling them for $600+ off contract. We can also probably assume that the gross margin on these phones is no worse than 30%. We know the material costs of the unit from tear down estimates are around $175 on the high side and a 30% gross margin would allow for another $175 costs for manufacturing, capitalized costs, etc. ... Using those assumptions and the analyst assumptions for unit volume the table below shows the gross margin that the Z10 sales would generate next year:
So we just used the Z10 sales estimates of an analyst who has a sell rating on the stock and a $9 price target. We assumed that service revenues will be cut in half from their current 2013 levels. All that being said, we then showed that BlackBerry would generate $2.1B in cash flow from sales of the Z10 product. This is critically important because this would more than offset the $1.6B of cash flow lost if service revenues were to be cut in half next year.
To sum up this point really as simply as I possibly can, you need to understand that a slow adoption of the new Z10 phone means that service revenues stay high and that the company keeps generating cash. If the Z10 is adopted more quickly than many analysts expect, the company will be generating enough profit from selling these phones to more than offset the loss of service revenues.
I simply have a hard time finding any justifiable reason why someone should short BlackBerry with any type of conviction. If you are a day trader and want to play the swings that might be okay. However, a long-term play assuming that BlackBerry is going to zero or going bankrupt would not be justified in my opinion.