BlackBerry Still Needs To Get Punished For Us To Get Interested

Jul. 9.13 | About: BlackBerry Ltd. (BBRY)

Canadian smartphone maker BlackBerry (NASDAQ:BBRY) reported weak results for its fiscal year 2014 first quarter last Friday morning. Revenue increased 9% year-over-year to $3.1 billion, which was well below consensus estimates. Earnings per share had several moving parts, but when adjusted for one-time issues, came in at a loss of $0.06. The loss was a drastic improvement from the same period a year ago when the company lost nearly $1 per share, but fell short of consensus expectations calling for a slight profit. BlackBerry 10 shipments were also below consensus estimates, coming in around 2.7 million units compared to the 3 million units the Street anticipated.

Geographic Performance

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Image Source: BBRY Q1 FY2014 Earnings Release

Geographic data reveals exactly what direction the business is moving: away from North America. During the launch of its newest signature smartphone, revenue in North America declined 4% year-over-year. In the US, and even BlackBerry's Canadian homeland, we think the firm simply waited too long to release a new product and is no longer relevant. Most data points continue to point to Apple's (NASDAQ:AAPL) dominance in the US, with Google (NASDAQ:GOOG) Android cemented in second place. Because the App Store and Google Play have such strong application offerings, there is no incentive for developers to create apps for the BlackBerry, which in turn makes customers less willing to join the operating system. CEO Thorsten Heins mentioned the "long sales cycle" of the enterprise market as a possible explanation of weakness, but we believe much of the enterprise has simply left BlackBerry behind. Perhaps the Q10, known for its classic BlackBerry "QWERTY" keyboard will sell a bit better, but we aren't feeling that confident about its prospects at the moment.

As for the consumer market, the BlackBerry brand no longer carries much weight, and the operating system has less than 5% market share in the US. With the launch of BBM (BlackBerry Messenger), BlackBerry is making one last attempt at North American consumer relevancy. However, other instant messaging clients like iChat, Kik, Snapchat, and Google Talk have made BBM substantially less compelling, and we doubt it will gain much traction in the US.

Sales gains in the Europe, Middle East and Africa segment were strong, but recent market share data suggests BlackBerry is down to 2.5% of sales market share in Europe. Android's 70% market share appears to be destroying the competition in European's largest markets, with Apple's iOS coming in a distant second, below 20%. Europe may not be a great area of growth for BlackBerry, but it is clear that the firm is performing relatively well in the Middle East and Africa.

Even after factoring in a $72 million loss on the Venezuelan currency devaluation, the firm saw its revenue decline 10% year-over-year in Latin America. On the other hand, results in Asia were solid, as revenues increased 27% year-over-year. This ultimately brings us to BlackBerry's number one issue at this time-what is the brand's future? Based on current demand from low-end Asian markets, we suspect the company's best route at this time is to pursue the low-end customer. This isn't as juicy as the high-end Apple/Samsung demographic, but it could be the main way for the company to stay afloat. BlackBerry's former cash cow, service revenues, is becoming less relevant, as even Heins admitted on the conference call, saying:

"Starting with Q2, we will not be provide this [subscribers] nonfinancial metric. As new service revenue is generated, we will look to provide additional information associated with these services and any other relevant details around service revenue trends."

In order to be successful as a low-end smartphone player, the firm is going to have to squeeze every dollar out of its supply chain and ultimately build (and sell) a lot more low-priced phones. BlackBerry will have to compete ferociously with the Microsoft (NASDAQ:MSFT) Nokia (NYSE:NOK) alliance as well as the dozens of manufacturers running Android to gain share in the low-end market. Apple might throw itself deeper into the mix as well, making this segment even more competitive.

A Closer Look at Blackberry's Financials

Taking a look at BlackBerry's financial statements, we see an uneven story. Gross margins are improving, though perhaps not as drastically as we might have liked. Free cash flow deteriorated, but only by $11 million. Compared to this time last year, the company's key financial metrics aren't deteriorating too badly, but the core business is certainly declining.

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Source: BBRY Q1 FY2014 Earnings Release

As far as the balance sheet is concerned, the firm's cash position isn't much different than the prior quarter, sitting at $2.8 billion versus $2.6 billion. Our big concern here is inventories, which increased 47% sequentially to $887 million ahead of the BlackBerry 10 global rollout. Unfortunately, we're not too excited about the potential of BlackBerry 10, particularly in the Western world, and we fear the company could be sitting on hundreds of millions of dollars of inventory that may be difficult to move. BlackBerry's inventory detail indicates that moving old product has become a slightly more prominent issue.

Valuentum's Take

Due to its high cash balance and lack of debt, we do not believe bankruptcy is in the cards anytime soon. However, we're seeing the company struggle to discover what the BlackBerry brand means, and importantly, where it belongs in the marketplace. It's easy to remember how popular BlackBerry smartphones were in the US just a few years ago, but the company has missed the shift to the application intensive world.

Ultimately, we're not surprised that the stock received such a substantial haircut after it garnered enthusiasm from its breathtaking run during the past year. The future of BlackBerry is highly dependent on how the company is able to capture market share in emerging markets. Any uptake in market share in North America would be gravy, in our view.

At the time of writing, we believe shares of the smartphone maker are too risky to add to the portfolio of our Best Ideas Newsletter. However, if the market continues to punish the company for its poor quarterly results, we could see the risk/reward tilt in our favor.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: AAPL is included in the portfolio of our Best Ideas Newsletter.