With BlackBerry's (BBRY) Q1 FY14 earnings report due on Friday, we have decided to discuss four major topics that may come up during the report as well as our expectations around these topics. These four topics include shipments vs. sell-through (channel fill), subscriber counts, service revenues, and short squeezes.
Shipments vs. Sell-through
There have been some notes by analysts wondering about BlackBerry's shipment versus sell-through levels on the BlackBerry 10 devices. New product lines are always going to have shipments in excess of sell-through due to the need for retailers and distributors to carry some inventory.
Apple's (AAPL) typical iPhone channel inventory ranges from 4 to 6 weeks. With the Z10 selling approximately 200,000 units per week at the end of the quarter, expected channel inventory would therefore be around 800,000 to 1.2 million units. The Z10's channel inventory was around 300,000 units at the beginning of the quarter, so inventory would increase by around 500,000 to 900,000 units. If the Q10's inventory level was the same (300,000 units) as the Z10's one month after launch, we'd expect shipments to exceed sell-through by around 800,000 to 1.2 million units.
If BB10 shipments exceed sell-through by more than 1.2 million units during this report, we'd likely see some downside to Q2 shipment volumes due to the channels already being well stocked for the Z10 and Q10. If BB10 shipments exceed sell-through by less than 800,000 units, there is likely some shipment upside in Q2 for additional channel fill due to the low inventory levels.
One of the more discussed aspects of BlackBerry's numbers is their subscriber count. There is some confusion about how subscriber counts are determined with BlackBerry 10 devices no longer requiring BIS, but we are operating off the assumption that BlackBerry 10 users are counted as subscribers since they are able to access various BlackBerry services. As Brian Bidulka noted on last quarter's conference call: "on the change in our definition of subscriber, when we made that change, there was no impact on the numbers we were reporting. And this quarter, in our numbers, we would be including the BB10 subscribers as well."
Below is a table that shows subscriber counts during recent quarters. The far right column shows the sell-through numbers that were needed to maintain subscriber levels during each quarter. Based on this information, it seems likely that sell-through of around 9 million units would be needed to maintain subscriber levels this quarter.
Beginning Subs (Million)
Ending Subs (Million)
Sell-through needed to maintain subscriber level (Million)
Q4 FY 12
Q1 FY 13
Q2 FY 13
Q3 FY 13
Q4 FY 13
There is a fairly high chance that BlackBerry's subscriber count will decline this quarter. The Z10 and Q10 are high-end devices that may not offset volume declines from the lower-end legacy devices to reach that 9 million mark.
However, we don't think that a subscriber count decline this quarter would be that significant. BlackBerry's growth from 70 million subscribers to 80 million subscribers was fueled by sacrificing device margins in order to sell devices, while hoping to recoup the losses on hardware via service fees. As noted in the table below, BlackBerry was losing around $25 on every device they sold during Q2 FY13. They managed to increase subscriber count by 2 million that quarter, but it came at a high cost. We project Q1 FY14 hardware gross margins at $90 per unit (based on a mix of 55% BB10 devices and 45% legacy devices), which is a level they last achieved two years ago. BlackBerry appears to be focusing on profitability now as opposed to increasing numbers via selling devices at a loss. If subscriber counts decline due to slowdowns in legacy device sales, while BlackBerry 10 device sales are solid, then it isn't a major issue. It would be significantly more concerning if BlackBerry 10 shipments fell short of general projections.
Q1 FY14 (Projected)
Gross Margin Per Handset
We feel that there has been a rather inordinate amount of concern about service revenues. Yes, service revenues are likely to go down significantly. However, it shouldn't matter very much where profits come from. Making $10 per unit up front and then $3 per month for 24 months ($82 total) has a similar result to making $82 per unit up front.
The main consequence of losing service revenue for consumer plans is that it removes a competitive advantage for BlackBerry in the low-end of the market. BlackBerry was able to heavily discount devices to sell them at a loss, while recouping that loss via service revenues. Now BlackBerry needs to make money on the BB10 devices, which means that they'd need to sell the devices at a higher price and/or make the supply chain and manufacturing process more efficient. On the other hand, BlackBerry now has a competitive operating system for the mid-range and high-end of the market, which is likely why BlackBerry is focusing more strongly there now.
The second consequence of losing service revenue for consumer plans is that it removes some of the revenue stream cushion that allowed BlackBerry to survive a period (and actually still maintain over $2 billion in cash and cash equivalents) when they were losing money with every phone they sold. BlackBerry can't fall behind the competition as much as they did in 2012 without serious financial consequences.
The table below shows hardware margins and service margins (based on $4 per month for 24 months and an 86% gross margin) for BlackBerry based on sales during select past fiscal periods. BlackBerry Q10/Z10 service revenues are based on 20% of units on enterprise plans at $25 per quarter for 24 months and 86% gross margins. For comparison an estimate of Q5 margins based on $300 ASP and 25% gross margins is included.
The Q10 and Z10 devices are quite profitable, and combined gross margin per user is similar to what BlackBerry achieved three years ago. The difference is that 82% of the Q10/Z10's gross margin comes from hardware sales versus 57% for the typical BlackBerry device three years ago. The Q5 has lower margins, but this is still around 75% higher than last year's average device, when service revenues needed to compensate for losses on device sales.
Q1 FY14 (Projected BB 10)
Gross Hardware Margin Per Handset
Gross Service Margin Per Handset
Total Gross Margin Per User
One scenario that has been discussed before is the possibility of a short squeeze. As of June 14 BlackBerry's short interest on NASDAQ had risen to 182.6 million shares. This represents around 37% of the public float, while the TSX has an estimated short interest of an additional 2-3%.
Three factors that would cause a significant short squeeze in combination are a strong earnings report, a high likelihood of a long time period without major negative news, and a high hard to borrow fee that results in significant costs for continuing to short a stock. These factors were all in play for Tesla (TSLA), where a strong earnings report forced shorts to contemplate the prospect of paying hard to borrow fees at a 40+% annual rate while waiting indefinitely for the prospect of bad news.
While there may be a short squeeze with BlackBerry, the effect is likely to be significantly smaller than Tesla's near 100% increase over three weeks. Although a strong report should resolve any questions about near-term uptake, shorts still have questions about BlackBerry's long-term prospects. As well, BlackBerry's hard to borrow fee currently is around 10-11%, which means that the cost to short BlackBerry's shares for one quarter is around 40 cents per share currently. This is significantly lower than Tesla's 40+% hard to borrow fee before their earnings report.
At those levels, if they are able to weather margin calls some shorts may be willing to pay the fee to continue shorting BlackBerry until the following earnings report if they still feel skeptical about BlackBerry's longer-term prospect. Others may decide to cover quickly and short again closer to Q2 earnings time in order to save on the hard to borrow fee.
However, if the hard to borrow fee increases from current levels, then more shorts will likely cover after a strong report. As well, if BlackBerry gives strong guidance for Q2 that will also likely trigger a major short squeeze since shorts would be faced with potentially waiting for six months to find major negative news while also continuing to pay hard to borrow fees.