I Won't Sell BlackBerry As Long As It Generates Cash

Aug.13.13 | About: BlackBerry Ltd. (BBRY)

BlackBerry (NASDAQ:BBRY) has been one of the biggest roller coasters in my portfolio. Earlier this year, as it was rallying towards $17.5 based on high expectations, I talked about how I would buy the company's shares at the next pullback; however, some of the company's investors told me that this was the last chance I had for buying the shares before they head back to $25-30. At the end, the pullback happened and I bought some shares, which I am still holding onto today.

A lot of times, when people talk about BlackBerry, it is mentioned that some investors are holding onto their shares even after they've seen big losses on their investments. The question that usually comes up is: "what will it take for those investors to sell their shares, didn't bad enough things happen already?" For me, there is one thing I am looking for in order to sell my shares; that's cash burn. If the company starts burning through cash, that will be my signal to sell the shares.

In the last quarter, BlackBerry generated $630 million from its operating activities and added $170 million to its cash reserves. Currently the company's cash reserves are at $3.07 billion (including long and short term investments which are pretty liquid).

Now, I can hear many of you telling me "hey Jacob, BlackBerry wouldn't have positive cash flow if it wasn't for the $564 million it received from the Canadian government in tax credits, it doesn't count because it was a one-off item." The fact is a little different though. BlackBerry has received tax credits from the Canadian government for the last 2 quarters in a row and it might continue to receive such tax benefits for a while, making it a recurrent income item rather than a one-time thing.

Canada currently has a program called Scientific Research and Experimental Development (SR&ED) Tax Incentive Program. Basically, the program offers money to companies or entities that invest heavily in research and development and create patentable technologies. As long as this program is in place and BlackBerry continues to create patentable technologies, it will continue to receive cash from the Canadian government.

Here is what the program's description says:

The SR&ED Program is a federal tax incentive program, administered by the Canada Revenue Agency (CRA) that encourages Canadian businesses of all sizes, and in all sectors to conduct research and development (R&D) in Canada. It is the largest single source of federal government support for industrial R&D. The SR&ED Program gives claimants cash refunds and / or tax credits for their expenditures on eligible R&D work done in Canada.

The good news is that the SR&ED program is here to stay for the foreseeable future and BlackBerry will continue to benefit from it for a while. This is just another source of revenue for the company until it gets its house in order and completes its turnaround efforts.

Staying cash flow positive is very important for BlackBerry because it will increase the probability that the company can be acquired from a private fund or another entity. Cash generation is sometimes seen as a more important metric than "net income" which can be manipulated by companies by using a few accounting tricks. Cash flow is difficult to manipulate, you either have it or not. In fact, on Monday morning, BlackBerry announced that it was open to several strategic options which include being acquired or going fully private. I'm sure there will be several potential suitors for the company, including some Asian companies that are attempting to be successful in the western countries as well as some private equity funds in Canada and the US. Due to the nature of BlackBerry's business, it is extremely unlikely that it can be legally bought by an entity outside of Canada (or perhaps the US). BlackBerry handles a lot of secure data including government and corporate secrets and this kind of data should be well-protected.

At this point, valuing BlackBerry is tough; however, I will use the company's cash flow rather than its net earnings to calculate its value. This is in line with what I said above about how private companies are more concerned about cash flow than net income. In the last 4 quarters, BlackBerry generated $886 million in free cash flow. If we discount the company's current net cash holdings, even if we assign it a price to cash flow ratio of 5, we still get a market value of $8.56 billion, which translates into $16 per share, which presents an upside of nearly 50% to today's share price. At first this may sound expensive; however, whoever buys the company at this price could recover their money in as little as 5 years if the company continues to generate the amount of cash flow it does today. It will be interesting to see how things play out.

Besides, as long as the company is cash flow positive, its book value will improve and downside risk will be decrease. Currently, BlackBerry's book value is around $9 billion, which is twice the company's market value. Unless a company is pretty close to announcing bankruptcy, it is very unlikely to trade for values much under its book value for long. Sooner or later, the smoke will clear, the panic will wear off and the company will trade for at least its book value. Given BlackBerry's cash position and lack of debt, I don't see the company going bankrupt anytime soon. The company could indeed get smaller, but it is very likely to stay alive for the foreseeable future.

Since BlackBerry is a volatile stock, it may be a good idea to sell calls to reduce your breakeven price if you don't have the stomach to add more shares of the company to average down. Because of the covered calls I wrote against my shares, my breakeven price fell from around $15 to $12 in the last few months. Be careful with writing calls though, because it may cause you to miss the train when the stock starts shooting up. It happened to me with Hewlett Packard (NYSE:HPQ) and Chesapeake (NYSE:CHK) in the last few months. While I profited greatly from both companies, I also left a lot of money on the table since both companies rallied much faster than I expected them to.

In conclusion, I don't plan on selling my BlackBerry shares as long as the company manages its cash flow well and stays cash flow positive. Keep in mind that I am not saying this is my "investment advice," rather, this is what I plan to do with my own investment. You may or may not follow me in this venture.

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.