Valuing A Triumphant BlackBerry

| About: BlackBerry Ltd. (BBRY)

BlackBerry's (NASDAQ:BBRY) Q10 is proving to be an instant success, selling out quickly on its first day in the UK. Prem Watsa recently claimed BBRY has an intrinsic value of about $40. Sentiment about BBRY seems to be changing. Now seems like a fine time to consider the company's upside.

In a recent article I mentioned that I think BlackBerry shares can trade above $50 within a year.

My optimistic analysis begins with a big if. My core question is: what could BBRY shares be worth by the end of FY2014 if BB10 succeeds beyond analyst expectations?

This question is timely because, at this moment, BB10 seems to be succeeding beyond expectations. It beat all earnings and most sales expectations last quarter by a considerable margin, and lingering pessimism will keep analysts' forward estimates low, creating opportunities for BBRY to surprise Wall Street quarter after quarter.

I approach this upside valuation by first estimating FY2014 earnings in a Triumphant Success Scenario and by guessing how the market would value those earnings in terms of P/E.

Factors Affecting Earnings in a Triumphant Success Scenario:

No one has a confident estimate for FY2014 earnings. Basing estimates on last year is misguided because the business really has been reinvented.

The product is totally different. This year's high-end product is competitive against the best smartphones on the market; last year's product was uncompetitive.

The Average Selling Price and margins are substantially increased. So far, Z10 and Q10's ASP appears to be above $400, and gross margins are above 40%. Last year's products have ASP of about $250 and gross margins around 30%.

The customer has changed. While this year's target consumer lives in the rich world, developing world consumers were the target and salvation of the company last year.

Revenue focus has changed. The company is transitioning away from subscriber fees, focusing on high-margin device sales.

Historic market share data is of limited use. BB10's current target customer was not represented in 2012 market share data because he was holding out for the delayed BB10 launch, creating an invisible pent-up-demand. In addition to this, considerable sales are coming from Android and IOS users (as much as 55% as of February).

Estimating FY2014 Earnings

By most accounts, BlackBerry's global smartphone market share has declined to about 5%. Globally, around 695M smartphones were sold last year and about 750M can be expected to be sold this year. If BlackBerry continues to hold a 5% global share, we can guess they will sell about 37 million phones this year. If they improve to 6%, we are looking at sales of roughly 45 million phones. It is crucial to remember that the customers that gave BBRY a 5% global market share last year are not the ones who will be buying high-margin BB10 devices.

US consumer polls (like this one published by a BlackBerry Bear) seem to imply that BB10 will win back about 5% of precious US market share.

Z10 went to market at about $750 and Q10 will be starting at $880. I assume an average selling price over the year of $400 on these devices. This attempts to vaguely account for a downward shift as Z10 and Q10 prices are reduced.

Last year's Average Selling Price per device was approximately $250. To account for continued sales of BB7 devices, the late-year release of reduced cost BB10 units, and a possible new playbook, I have assumed that the total ASP on BBRY's devices will be about $350.

We know that the inclusion of one million Z10 device sales to six million BB7 sales last quarter was sufficient to bump gross margins on devices to 40% from 30%, where they have lingered for the past year. This implies Z10 margins currently in excess of 50%. I use the current 40% margins in my estimates.

Considering all of this, what can we guess about the device contribution to FY2014 earnings?

If the triumphant scenario involves:

  • Sales of 35 to 45 million devices (eg. 12-24M Z10s, 12-24M Q10s, 12-24M BB7 and new devices),
  • Average Selling Price of $350,
  • 40% margins;

Then we are looking at:

  • Device sales of $12-$16B
  • Device profits of $4.9-$6.3B.

Add to this about $3.5B in service revenues (assuming 15% less than last year) less $0.7B cost of services (assuming 15% more than last year), and we are looking at FY2014 profits in the vicinity of $7.7-$9.1B.

Operating costs seem likely to be similar to last year, with the final benefits of the $1B cost reduction scheme offset by increased selling and marketing costs associated with the BB10 launch. I have assumed $3.5B in R&D, administrative, and selling expenses. This leaves us with $4.2-$5.6B Earnings Before Tax. BlackBerry's tax rate in previous high-earnings years has been about 35%. After deducting taxes, we arrive at:

A Triumphant Scenario FY2014 Earnings Estimate of $2.7-$3.6B.

This is in the same ballpark as previous top earnings years. In FY2011 net income was $3.4B on $16B hardware sales. While BBRY's market share is now considerably lower than it was in FY2011, today's total smartphone market is considerably larger.

P/E in a Triumphant Case:

Guessing how the market will value BBRY stock as the company emerges as a heroic comeback kid is tricky.

The average P/E in the smartphone industry is in decline as the industry transitions from a rapid growth to a more mature phase. Apple (NASDAQ:AAPL) shares are currently priced at about 10 times earnings, Google (NASDAQ:GOOG) is at 24, Microsoft (NASDAQ:MSFT) is at 16, Samsung (OTC:SSNLF) is (seemingly) at 10.

I will assume that if BBRY lives the dramatic turnaround story that I have estimated above, their P/E will get to about 10.

With a measly market cap of $7.8B, BlackBerry has much more room to grow in existing markets than Apple, Microsoft, or Google, with market caps of $400B, $240B, $260B respectively. I have assumed that its growth potential, given a turnaround story and a killer earnings year becoming evident, would allow the company to find a 10 P/E by fiscal year-end February 2014.

With a P/E of 10 and earnings reflecting my triumphant case estimates, the total market cap should have appreciated to about $27-$36B, a multiple of 3.5 to 4.5 its current levels. The share price would be $52-$69.

Reality Check

These estimates are all extremely hazy. I am considering only a triumphant scenario. And I have probably made errors which the SA community will help me identify.

For my purposes, these estimates are enough to persuade me to remain hyper-bullish, dreaming of fruitful short squeezes.

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.