To a limited extent, BlackBerry's (NASDAQ:BBRY) current performance is reminiscent of a dotcom's. Fourteen years ago, any company even mildly associated with the internet could list itself with no profits and yet see its stock rise on the basis that it carried some disruptive technology (supported by previously unheard-of metrics) and had the potential to become larger than any number of stodgy, established firms.
BlackBerry - the company formerly known as Research In Motion - has seen its stock rise by a spectacular 121% since closing at a low of $6.31 in late September 2012. At one point in the past 6-1/2 months, BlackBerry had nearly tripled in value from that low point. Its performance handily beats the return of all the major indices over the same period - in fact, its return since that low point is 15.7 times that of the S&P 500's.
Yet, BlackBerry currently has no profits and while it's expected to see a bit of a rebound in earnings this year - analysts expect it to earn 44-cents per share - by 2014 its earnings are expected to plunge 87% to 5-cents per share.
This is why we believe that BlackBerry is redolent of dotcom stocks - it has negative trailing earnings, it is connected with the tech sector du jour (smartphones) and is relying on expectations regarding its future to buoy its stock.
That said, BlackBerry was a well-established company before both Android and iOS decimated its market share and its technology and devices still have a loyal following - such as the U.S. Department of Defense - that it could survive indefinitely as a small niche player. Yet it's hard to imagine the market awarding triple-digit returns to a company for being a small niche player - there is clearly a war of expectations going on.
What's Going On?
A large part of BlackBerry's recent performance can be attributed to two things: first, surprising earnings and second, anticipation surrounding its new products, BlackBerry OS10 and two new handsets bearing it, the Z10 and Q10.
Specifically, BlackBerry trumped expectations by a profit of 19-cents per share in its fiscal Q4 2013 - that helped it beat expectations by 49% for its fiscal 2013. While that would be the impetus for a strong rally in the stock price, it would not have been sustainable if BlackBerry had failed to come to market with its new generation of products, particularly the Z10 - but the company has done a good job of bringing the device to market, introducing it not only in developed markets such as the United States, the United Kingdom and Europe but also in the emerging markets of Asia.
Meanwhile, the BlackBerry Z10, which debuted to mostly-positive reviews, saw initial sales of 1 million units, helping to generate buzz that the company had begun to turnaround. However, there are conflicting accounts as to whether the device is doing well or poorly and there are even conflicting reports as to whether there are handset returns.
Clearly, BlackBerry still has some heavy lifting to do.
More Downside Ahead
BlackBerry has come off its highs but we believe that the stock is headed for more consolidation down the road. Here's why:
1. Weak Forward Earnings. As mentioned, BlackBerry is expected to earn 44 cents this year but only 5 cents the following year. That would give it a negative two-year revenue growth rate. In contrast, its competitors are expected to show earnings growth of 10.7% this year and 30% the following year.
To be fair, analyst estimates, particularly those for periods further out, are subject to numerous adjustments, but current market prices are based on all available information at present; as such, the market is aware that earnings are expected to slow considerably just 8 months down the line - and that may have been the impetus for the stock's ongoing consolidation.
Yet this does tell us something. Forward estimates are usually updated as a whole - meaning that the same analysts who saw BlackBerry recovering its revenues in fiscal 2014 didn't expect it to sustain its performance in the following year - it might very well be that while BlackBerry's fiscal 2014 is expected to be a rebound year, its fiscal 2015 is expected to see a continuation of BlackBerry's slow decline.
Specifically, IDC estimates that BlackBerry OS's market share will decline from 4.7% in 2012 to just 4.1% by 2016 - in contrast with the fortunes of Windows Phone, which is expected to eat into the market shares of both Android and BlackBerry OS and register 11.4% market share by 2016 - placing it a strong third in the smartphone league tables.
The market share effect is compounded by expectations that 2.2 billion smartphones will ship by 2016 - half a billion more than in 2012 - so there would be nearly three Windows Phone devices for every BlackBerry handset by then. That would be a complete reversal from 2012, when there were two BlackBerry devices shipped for every Windows Phone device.
What's more, the top incumbents, Android and iOS, are likely to maintain their stranglehold on the top two spots - indeed, IDC expects Android to have a market share of nearly 63.8% by 2016 (down slightly) while iOS should have a 19% slice.
Moreover, Facebook (NASDAQ:FB), and now Twitter, are venturing into the mobile device space, as is Mozilla. Success by any one of the social networks could lead to them developing their own, low-cost smartphone devices built around their existing platforms, complicating the race for third.
In that sense, a bet on BlackBerry today may very well be a bet on fourth place.
3. Acquisition Target? While BlackBerry is still working on its profitability, it nevertheless retains a strong balance sheet. Specifically, it has good levels of cash - both its current and quick ratios, at 1.7 and 2.1, respectively, are far higher than its industry peer group's and it has no debt. That means that any company seeking to acquire it would be getting its operating cash flows to itself.
This is the reason that BlackBerry has dealt with rumors of being bought out by other technology companies - at one point, Microsoft was purportedly interested in the company. Yet BlackBerry has constantly reiterated that it will remain independent, but that won't stop the rumors from persisting, especially if the sales of its new products prove to be disappointing.
Given this "will it" or "won't it" cycle, it's not surprising that its beta is at 1.7 - 27% higher than its peers. While an acquisition would certainly provide some benefit to BlackBerry shareholders, the volatility involved in the stock does not justify the potential upside, especially considering the run that the stock has already had. It's one thing if the stock were trading at $6 with an offer to buy it at $12 and quite another for a stock at $13 being bought for $17 per share - a 30% price premium isn't worth the wide price swings if the market as a whole consolidates. Investors are better off investing in established firms such as Johnson & Johnson (NYSE:JNJ), which we wrote about recently, for 20-to-30% upside with lower price volatility.
All told, we believe that the best has been seen from BlackBerry - its run up over the past six months may have already exhausted any potential upside. Now is the time for the company to show results but on the basis of what we've seen so far, we would not recommend it.
Additional disclosure: Black Coral Research is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.