Everyone is now clearly aware of how badly BlackBerry (NASDAQ:BBRY) disappointed when the company released its Q1 2014 earnings report at the end of June. With the stock down 35% since the debacle of an earnings report, the ~$5B market capitalization the company trades with is less than the liquidation value of BlackBerry today. This is even if you assume that the intangible assets, patents, and intellectual property that BlackBerry carries on its balance sheet are worthless (these items are reported at a value of ~$3.5B as of Q1 2014). The market is essentially now forecasting the BlackBerry will not be sold and will burn through its cash balance of over $3B, which is 60% of its current market capitalization. This leads me to the perception problem that BlackBerry now faces. The perception problem centers around the competence of the current management team and its strategy going forward. Secondarily, the perception problem is one of how enterprise (business/government) customers view the launch of the BB10 platform and if the company has time to convince these critical customers that the launch is not a failure. My opinion is that the negative perception is outweighing any type of value the company can create for shareholders going forward. I do not think the company will end up in a position where it ultimately destroys shareholder value (i.e., burning all its cash) but the market currently disagrees.
Over 18 months have now passed since January 2012 when Thorsten Heins was named the new CEO of BlackBerry. That simply marked the beginning of a wholesale transition at the upper echelon management level within the company. The company made a big deal with the hiring of a new COO and CMO shortly after Mr. Heins took the helm. Here we are 12-18 months down the road from the management transition, and I think it is fair to say that it is time to question whether or not the BlackBerry management team is up to snuff.
One of the first actions that Mr. Heins took after being named CEO was to delay the launch of the company's new phones as the BB10 operating system was not ready. This was a smart move, as releasing a half baked product would have clearly been the nail in the coffin for BlackBerry. The problem with delaying the product launch for over a year from its originally anticipated date was that expectations rose during that time period as well. The BlackBerry management team has pretty much made it clear that the first BB10 phone launched, the Z10, was the best the company had to offer as it would be the first full touch screen phone ever released by the company. Sure, the Q10 phone with the keyboard will appeal to hardcore BlackBerry users and those few remaining zealots who desire a keyboard. Undoubtedly the lower end Q5 phone will have at least a certain level of success in international markets where the BlackBerry Curve has been a staple for many years. I also do not doubt that BlackBerry will continue to innovate and introduce a 5in phone at some time in the near future as the rumor mill currently anticipates. However, the problem for BlackBerry investors is that you have probably seen the best the company has to offer. I have no doubt that each future generation of BB10 phones will be an improvement upon the last in terms of hardware and software, but this is no different from the dynamic seen at any other phone manufacturer.
On the Q1 2014 earnings call, Mr. Heins noted that this current year would be a transitional year by way of trying to negate the negative perception surrounding the lackluster launch of the BB10 phones. This sure is a transitional year for the company, but it should be the year that the company transitions into a formidable player in the smart phone industry. There is zero evidence to suggest that BlackBerry should see any type of increase in velocity in terms of the unit sales for BB10. If anything, the pent up demand from its 70M+ existing user base and those tech junkies just looking for the latest and greatest platform should have driven phenomenal sales right out of the gate.
The management perception question comes down to a very simple point. The market is assuming that BlackBerry will destroy shareholder value in the coming months and years. The market is assuming the company will burn cash while building inventory, implementing heavy marketing trying to drive consumer awareness, and through falling service revenue. In a nutshell, the market is saying that management is not prepared to take the necessary actions to preserve shareholder value. This could be though any number of strategic actions available, licensing the BB10 platform, selling assets, or an outright acquisition of the company. The market is saying that BlackBerry management will continue down a path of trying to rebuild the brand and in doing so will burn down the house, leaving a much less desirable asset than the company presents today.
Enterprise Customer Perception
For the sake of simplicity, I am going to lump business and governments together in this discussion. It should be clear to most that governments are significant BlackBerry customers due to the best in class security features of these phones. It should also be clear that these same governments who could once be counted on to be loyal BlackBerry customers are starting to embrace the Bring Your Own Device "BYOD" theme. In the business world, the reality is that BYOD is here to stay. The real question in the business world is will companies be willing to incur the infrastructure cost required to support the new BB10 phones. The BlackBerry server software that is currently deployed by businesses will not support the BB10 phones currently hitting the market. This is where the perception issue comes into play as companies have a decision in whether they want to incur an infrastructure cost to support a BlackBerry platform that might be on life support.
In the first quarter that the BB10 phones were available for sale, BlackBerry sold close to 1M of these phones after being available for sale for just about 1 month. During that time period, only the Z10 was available for sale, and it was only available in a limited number of markets. During Q1 2014, the second quarter that BB10 phones were available for sale, the company sold about 2.7M of these phones. Here is the simple reality of why this is an awful number. The Z10 was available for sale for 3 months in a significantly larger number of markets, including the US. The Q10 was available for almost a full month in a number of markets. The company sold less than 1M phones a month in Q1 2014 while having significantly expanded its addressable market and introducing a new product. Put another way, the momentum slowed in just the second quarter after the launch of the new flagship product and operating system for BlackBerry. There is no way to spin this other than to admit that the launch has been terrible, although Mr. Heins certainly tried to spin the results as best he could on the earnings call.
BlackBerry recently announced that 60% of the Fortune 500 companies have ordered or installed the BB10 Enterprise software needed to manage the next generation offering from the company. This was most likely intended to be a positive announcement, but I think it simply highlights the uphill battle the company faces. The company has already gone after the low hanging fruit, that being the world's largest companies and governments. These were easy targets with deep pockets and reason to desire the high level of security associated with BlackBerry. Even with this level of adoption, sales are already slowing. This highlights the problem the company faces in that it needs to have enterprise customers of all sizes, not just Fortune 500 companies if it is going to succeed in this space. It is also these smaller companies that are not going to be willing to incur the cost to upgrade their IT infrastructure to support a system that is no longer desired by the majority or their employees.
Can The Perception Be Changed And The Investment Outlook
As an investor, I would love to hear Mr. Heins say that the company has a stated goal and that if the sales levels do not reach that goal within 12 months of launching the new phones, then all options will be on the table. I very much believe that there is inherent value in the operating system that BlackBerry has built, and any number of companies would pounce at the chance to buy BlackBerry at a value at least 50% above where the company trades today. Unfortunately, I think that management has a much longer time horizon and with that comes uncertainty about whether or not management will wait too long to maximize value.
I think the damage is already done from an enterprise standpoint. BlackBerry promised a revolutionary platform and the initial reaction has been blah. There is no earthly reason why the sales momentum should have slowed in the second quarter of the BB10 phones being on the market with a significantly increased available market.
I am firmly in the camp that the company is significantly undervalued, even if my faith in company management is more in line with the market perception. I strongly believe that some sort of activist investor will soon emerge who sees a company trading for far less than its tangible book value and will agitate for management to take action now to preserve that value. Those who bought BlackBerry when the stock was trading for $20 might not be happy, but those who buy the stock while it currently trades for under $10 a share would have no problem with the company being sold at a price 50% higher than it trades at today.