Summary: The BlackBerry (BBRY) story will remain a service revenue story for many years to come. The view on the future of service revenue will remain the key debate on the stock. I believe that BlackBerry can achieve an EPS of $2.50/share in 2014. That could help the share to continue to run from current levels.
Beginning of recovery or end of hope - I think it is a combination of both
It is not difficult to argue that BlackBerry is at the beginning of a recovery or at the end of hope after Q4 2013 results.
Beginning of recovery
The gross margin of 40% is much higher than the low 30% consensus estimate. The beat is mainly from better gross margin on the hardware side. Device gross margin is estimated to be at 12% this quarter compared to -3% last quarter. BB10 bears 25% gross margins. I believe that this gross margin is sustainable. If we look at the industry, other than low cost Chinese makers, most handset makers bear 20%-30% gross margins. As BB10 will account for a bigger portion of group sale, the company's gross margins should continue to improve. On an EBIT level, BlackBerry broke even this quarter. It looks like we are at a turning point.
Management also said that 55% of Z10 customers globally are coming from platforms other than BlackBerry. More importantly, ARPU stopped declining this quarter. ARPU has dropped from $5.2 in Q1 2012 to $4.08 in Q3 2013. Most investors are expecting further drops in the future. This is the first quarter we see stabilizing ARPU. ARPU in Q4 2013 should stay at the $4.08 level. It looks like most of the damage to service revenue is done.
If we believe that BlackBerry can continue to charge a service fee for BB10 users, we should be a buyer of the stock here. BlackBerry will become profitable with a strong balance sheet. BlackBerry is likely to become a profitable niche player in the future as there are enough users who have 'fat fingers' and prefer physical keyboards.
BlackBerry can become a profitable company again with a long-term EPS of $2.5. Putting a 10x P/E, we can get to $25 price target, implying a 70% upside. With 35% of the float shorted, I believe that the bear case is well understood.
End of hope
We can also argue that this quarterly result marks the end of hope. In the last two years, many investors are hoping that BB10 will be great and save BlackBerry. That looks very similar to what happened to Palm Web OS and Nokia's (NOK) Lumia phone. Both Palm and Nokia failed to match investors' hopes. BlackBerry may be the same. The OS war is finished! In Q4 2012, Android has 70% market share. iOS claims 21% market share while BlackBerry holds 3.2% and the Windows system holds 2.6%. It is very obvious that Android and iOS have won the operating system war.
BlackBerry has lost its competitive advantage. E-mail function, security, full size keyboards and BBM are BlackBerry's key competitive advantages in the last few years. Right now, most of those have become a common function for a smartphone. E-mail is available in all smartphones. Whatsapp is becoming the most popular cross-platform messenger. Without a competitive advantage, it will be difficult for BlackBerry to get sustainable profit. In the handset space, profit can disappear in a few quarters. We have learned that lesson from Nokia and HTC.
Recent data shows that 55% of the Z10 customers globally are coming from platforms other than BlackBerry. Even so, they are still losing subscribers. That means a lot more BlackBerry users are moving out of the platform than those who move in.
Service revenue may be at risk. The CEO said BB10 is moving to a different business model on the services. They may have difficulty in charging the service revenue in new devices.
Z10 is a decent device. However, it may be too late. Let's remind ourselves of what happened to Palm. Their WebOS is a decent system. I have a very similar feeling toward BlackBerry's Z10 and Palm OS. It is a proper operating system but is too late. Consumers can choose from iOS,, Android and Microsoft (MSFT) Windows systems, all of which are more mature than BlackBerry's BB10. The consumer has little incentive to choose Z10 over other smartphones. In consumer technology, it is about innovation, not catching up. BB10 has a lack of killer features to regain market share.
Lenovo (OTCPK:LNVGY) is highly unlikely to buy BlackBerry. I believe that many US government/corporate groups will replace their BlackBerrys with iPhones if BlackBerry gets bought by Lenovo. No one wants to see that happening.
Overall, I think we should not expect BlackBerry to be as great as it used to be. It may not be able to gain market share in the smartphone market. However, if management continues to execute, it may become a profitable niche player, which could be worth $25/share.