Being on the receiving end of most Wall Street analyst reports, I can report without a doubt that BlackBerry's (NASDAQ:BBRY) management has managed alienate almost every last Wall Street bull. As an investor, you also understand that Friday's earnings debacle severely damaged the brand as media reports permeate now about BlackBerry's imminent demise. This will dissuade consumers and enterprise from adopting anything BlackBerry including the Q10 and BES10. This destruction of brand equity by Heins and Co. is unforgivable.
Before going into a deep dive trying to understand how we landed in this mess below are highlights of the Earnings release:
Guiding to Operating Losses in Q2: The company continues to look for operating losses in Q2 and continued investment in 2014.
-- Implications for BlackBerry's cash pile are ominous
BB 10 Volumes Disappointing: BB 10 volumes to date have disappointed.
-- This really refers to the Z10 here which I believe to be the main culprit.
Inventory grew to $887M vs. $603M last quarter: - Suggests BB10, mostly the Z10, has less demand than expected by BBRY management team. At these levels, some analyst claim up to 1Million Z10 devices maybe sitting on the balance sheet.
-- Mitigating factor overlooked by analysts: Works in Progress will bloat inventory as they are now building 3 devices vs. 1 last quarter, so 3x Works in Progress accounts for some of the bloat.
-- Given late build of Q10 discussed below, the inventory is primarily made up of [Works in Progress x 3 devices + Z10s] this means the Q10 / Q5 are NOT the problem here. The Z10, that's another story.
-- Gross Margin Disappointed: The margin bump from BB10 devices was missing hinting at discounting for the Z10. Estimated gross margin for devices was 34%, slightly higher than last quarter despite the much higher mix of BB 10 devices in the volumes: 40% this quarter versus 16% last quarter. (Venezuela distractions exacerbated this by 2%, but still a critical miss.)
Subscribers fell 4M q/q to 72M: These are accelerating from a 3M decline in FQ4. To make things worse, management is not planning to disclose monthly subs, limiting visibility.
-- Lack of transparency is simply awful and arrogant; the street will not let this slide.
The above is pretty dismal and we now understand how the stock lost 30% on Friday. Let's take a look at how we got into this mess:
The Bungled Launch Strategy
Our Channel checks across the U.K. and Canada three weeks ago suggested that the Q10 is doing very well. However the Z10 is facing increasing pressure, while many attributed this to the Q10, store reps in both continents made a similar comment along the lines "it's going to be very difficult to sell the BlackBerry Z10 now that BBM has gone cross platform and you can get it on an Android or Apple."
This scared me as it brought me back to the original reason I wrote my second BlackBerry SA article "London Calling on a BB10." How could BlackBerry ever sell a flat screen device? Well the answer to that question was simply BBM. Did anybody buy the Z10 because of swipe and peek? No. I think early Z10 adopters bought it for BBM, which is now free to all.
Heinz was bold and intentionally forced to Z10 upon consumers first because he knew the Q10 would kill any chance the Z10 had of being even a moderate success. BlackBerry people are simply Qwerty lovers. And as those store reps suggested, with the Q10 in store, and the exclusive allure of BBM no longer pulling, the Z10 died. I don't mean to take away from BB10 being a masterfully crafted OS as witnessed by Apple's recent imitation of swiping and peeking. (Remember, imitation is flattery, and this is a tip of the hat from the masters of design at Apple to the design team at BlackBerry.) It is just that no one bought the Z10 for Swipe/Peek and nor for QNX. They bought it simply for BBM.
When Heins announced at BB Live the opening of up BBM, investors assumed that the BB10 OS launch had been successful enough for him to lose BBM pull. Did he not "peek" over to his balance sheet to see those Z10s sitting there? Without BBM, he's now stuck with piles of Z10s in inventory that he's going to have to write down. There goes another cash pile.
So now we have begun to unravel the riddle behind the inventory pile sitting on the balance sheets. All the channel checks we have done point to a brisk selling Q10, so that leaves a mix of work in progress for the Q5 and Q10 build outs … and piles of Z10. I further believe that the Q10 only went into production in late April. BlackBerry almost short shipped Selfridge's as well as most of the U.K. retailers in the first few weeks of May. BlackBerry didn't short ship on purpose as others would have you believe. Developers we had spoken to suggested that considerable software changes where needed for the Q10s smaller 720 x 720 screen and the keyboard input. These were quite difficult and caused delays until they could have a final "lock down" production unit.
This explains why the Q10 went from an April launch in the U.K., to an April 26th launch in one store, finally to an April 29th launch at other Carphonewarehouses. Many U.K. retailers did not receive Q10s until mid May. This also accounts for the ensuing delays in launching the U.S. This sparse Q10 production lends further credence to the Z10 as being the behind the pile of inventory sitting on the balance sheet … These Z10s will need to be discounted, hurting margins going forward at the expense of the Q10/Q5.
The decision to launch the Z10 first delayed severely worsened the Q10's launch. The decision to overbuild the Z10 led the horrific balance sheet bloat and low sell-in figures that caused the stock to tank Friday. The brand damage will now hurt the Q10s chance of success. This was a catastrophic comedy of errors.
What can possibly make this worse? For one BlackBerry haven't even so much as hinted of the release of the second most popular keyboard device, the BlackBerry 9800 Torch 'slider.' Rather, Mr. Heins is going repeat the Z10 mistake again with the BlackBerry 'A10 Phablet' as he insists on pushing flat screens upon an unwilling Qwerty audience. I'm dreading those build numbers, aren't you? Mr. Heins vision "Mobile Computing end points" has emboldened him to completely ignore his core keyboard loving audience and burden his balance sheet. But wait, we can do mobile uploads to our car's OS with our new phablets? Say what?
Many have complained of the lack of marketing spend and user awareness, all the while Heins and Co. loaded up on brand building with "mega sponsorships." I anticipate $200M in Z10 write-downs are coming. Can you imagine what kind of support Heins would have obtained from AT&T (NYSE:T) and others had he shown them a $50M Media plan surrounding AT&T Q10s? A lot more than shoving Z10's in store without support as they have?
There is clear lack of down to earth business acumen in terms of manufacturing, distribution, and marketing. The Q10 might be a marvel, but no one will get to see it the way events are unfolding at BlackBerry.
Failure Managing Wall Street
Unfortunately for shareholders, telegraphing what is really going on at BlackBerry, beyond the incessant delays, has been a permanent Achilles heel as we witnessed Friday. The last message he sent to share holders was that BlackBerry would sell '10s of millions of BB10 devices.' Ouch.
It was a painfully delusional hour-long investor call as Heins waffled on hanging on to meaningless buzzwords like "mobile end computing devices," "the Internet of things." These obtuse concepts appear as smoke screens, pie in the sky stuff, to dress the company as a visionary in technological leadership. He babbled on about BBM without alluding for one second as to how that would be monetized. He even dared waste investor time with a tremendous new automotive uploads segment. Really Mr. Heins?
We saw this leadership style during the fireside chat nature of BB live, an unmitigated disaster marred by interviews with Alicia Keys and Lewis Hamilton that made investors feel queasy. We accepted these under the vague notions that they might help rejuvenate the brand. They paraded a Bentley with a video call and an engineer from Mercedes, clearly new found F1 friend, neither of which had any particular relevance to the future of the company. I thought I had video calls on my handset already? Do consumers really care to update their car's PC with mobile phone? Really guys?
I had the good fortune of discussing BlackBerry with a mobile business leader in telecom, someone who buys lots of Blackberries. The first thing he told me was that he did not like management much on a personal level. A comment was made to the nature that they had spent the last year traveling around on the G5 while the company was burning cash. He was not impressed. He was most unhappy that they had launched the Z10 first and laid this decision clearly on Heins vs. technological issues I alluded to earlier. Who knows? It didn't matter because given the stature of gentleman in question I was shell-shocked. I called a fund manager I discuss BlackBerry with and we talked ourselves into ignoring these nuggets based on the personal overtones. Such was our greed and self delusion. Clearly we can guess at what happened now: Heins must have pulled Z10s and phablets out of his briefcase and announced delays on Q10s and no Torch 9800 sliders … and then probably spat out "Internet of things" or "QNX" or some other gibberish.
Later, when I heard that Mr. Heins only flew back from Asia on the eve of the disastrous U.S. launch, I was shell-shocked. It conjured up images of the CEO enjoying the F1 Asian races, doing some business, and completely fumbling the ball on the US launch that led to a 15%-20% share decline and the loss of the Goldman analyst as a leading bull. All this on our G5. I wonder, did he call Alicia Keys to say hi from 45,000 feet?
The "We will sell tens of millions of BB10 devices" comment provided an unfound sense of comfort to investors and analysts. The guidance error is just the last straw in a string of poor communications and guidance that will leave the board with little choice but to replace the beleaguered Mr. Heins or accelerate the 'strategic review'. The damage to the brand from the 30% drop in stock price cannot be downplayed. Morgan Stanley's Gelblum put it most eloquently:
"We fear consumer opinion, and thereby enterprise adoption, of BB10 could have been materially harmed by today's earnings, given the falling stock price and negative buzz that will undoubtedly follow in the media and online."
In other words the brand has sustained severe damage at the consumer and the enterprise level. Imagine how an enterprise, which may be sitting on the fence considering BES10, is going to feel about deploying BES10 if they read that the company is soon going out of business?
The million dollar question is the following: Can an OS survive with just a Qwerty phone?
While it's nice to know that the phablets and Z10s exist, BlackBerries have always been about the keyboard. There is a sub segment of people who want a keyboard and don't care for touchscreen phones. BlackBerry has a tiny market share because the BB7 product had fallen so far behind the times. I have no doubt that BlackBerry Q line will be a huge hit in that segment of users who prefer keyboards. Maybe that's only 8% of the US mobile population? Fine, that should be plenty for the company to live on. The question is finding someone to navigate BlackBerry through this difficult period.
The Board Must Step In on July 9th
There is an "insouciance" to Mr. Heins' leadership that truly scares me. He believes he has been handed in unbridled mandate to turn BlackBerry around and that waffling on with obscure technological constructs can replace hardened strategy and business acumen. To this lofty end he has ignored his core audience. A return of "group think" and a dislocation from reality, thinking that led to BlackBerry's original fall from grace, have now returned to Waterloo. Come July 9th I do not believe that board of directors will stand by and abdicate its fiduciary duties by allowing the CTO continue in his leadership role. Mr. Heins has delivered a 1st class product, so kudos there, but he was never meant to be a CEO nor a strategist. I cannot believe that the board of BlackBerry has given him a blank check to run amuck and deliver his oddly unique vision of "mobile end computing devices" at the cost of hundreds of millions of dollars in Z10 write downs and the priceless damage to hoisted on the brand Friday. Remember I wrote earlier that "Great Brands Die hard?" Well they will die quickly in the hands of a leader who believes that tablets are "not a good business model."
In the meantime the stock is un-investable as long as Heins remains CEO. The phone is a superb device, and the QNX build is fantastic, so Mr. Heins must be properly thanked for that and has earned a permanent place on the board. He has created a winning product with the Qline, it's just the delivery that missed.
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. I have cut my position back significantly and may continue to do so.