BlackBerry (BBRY) recently issued an earnings warning for Q2 FY2014, with revenue and shipments significantly below analyst estimates, although sell-through levels were generally more respectable. It also had a writeoff of nearly $1 billion, mainly due to BlackBerry Z10 devices. We are going to look at five of the more interesting issues arising from BlackBerry's warning.
BlackBerry 10 Sell-Through Is Disturbingly Low
Most of the BlackBerry devices shipped in Q2 FY2014 were BlackBerry 7 devices. This is backed up by the average ASP, which would be only $230 if hardware revenues were $850 million. This is a similar ASP to before BlackBerry 10 was introduced. There may have been some Q5s shipped since its ASP would be lower, but shipments of the Z10/Q10 are likely no more than a few hundred thousand at most during the second quarter.
Since approximately 3.7 million Z10/Q10s were shipped in the previous two quarters, combined Z10/Q10 shipments are probably around 4 million or less with sell-through somewhat less than that. We're estimating that sell-through of the Z10/Q10 is probably over 3 million though since the BlackBerry OS channel inventory has been drawn down for most of the last 2.5 years. As noted by SA author Michael Blair, the sell-through trends for BlackBerry 10 devices are quite unclear, and BlackBerry needs to be more forthcoming about sell-through levels during the Q2 FY2014 conference call. Was sell-through very poor during Q1 FY2014, and improved during Q2 FY2014, but not enough to clear through channel inventory? Or was sell-through at a generally low level throughout both quarters?
BlackBerry Had An Incredible Amount Of BlackBerry OS Inventory In Channel Before FY2012
BlackBerry's sell-through has been equal to or above shipments for 9 of the past 10 quarters. Sell-through figures have averaged 18% above shipments since the beginning of FY2012, meaning that channel inventory has fallen by 15.9 million units over that period. Since sell-through of BlackBerry 10 is going to be logically lower than shipments, that means that BlackBerry probably had at least 17 million units in channel inventory at the start of FY2012. Since BlackBerry's maximum quarterly sell-through was around 14.5 million units, that represents 15 weeks of inventory at maximum sell-through rates. Targeted channel inventory levels are usually around 4 to 6 weeks.
BlackBerry appears to have done a lot of channel stuffing prior to FY2012. That has hurt the perception of BlackBerry as the lower shipment numbers get reported and make BlackBerry appear to be doing somewhat worse than it actually is. The "loss" of revenue since the beginning of FY2012 due to that prior channel stuffing is around $4 billion.
Channel Inventory Reduction (Million)
BlackBerry's Declining Cash Is Offset By $393 Million Increase In Tax Receivables
BlackBerry's cash and investments decreased from $3.1 billion to $2.6 billion, which is a decrease of $500 million, or around $0.95 per share. However, one useful effect of the writeoff and restructuring charges is that BlackBerry gets an extra $270 million in income tax recovery from those charges (using FY 2013's 26.6% tax rate). As well, BlackBerry should accumulate an extra $30 million in R&D tax credits (we are not sure if this is only an annual event of $120+ million, but we are going to use the quarterly amount for illustrative purposes), plus another $93 million in income tax recovery from its operation loss excluding writeoffs and restructuring charges. This results in a $393 million increase in income taxes receivable. This will help slow BlackBerry's cash burn rate as it seeks to reduce operating expenses. Below is a look at how the quarter approximately went based on BlackBerry's press release.
Income From Operations (Excluding Writeoffs, Restructuring Charges)
Income Before Taxes
Income Tax Recovery
Future Z10 Sell-Through Will Tell Us More About Whether The BlackBerry 10 OS Has A Shot At Redemption
The majority of the $930 million to $960 million writeoff is attributable to the BlackBerry Z10 devices, which are going to be repositioned as entry-level smartphones. We will need to see the new pricing, but given the size of the writeoff, the price drop could be very significant. This gives us a chance to see whether the premium pricing of BlackBerry 10 phones was responsible for the weak sales, or whether consumers and businesses are willing to give BlackBerry 10 a chance when good value phones are available. While there probably isn't much of a business model in selling phones at a loss (at least when there are limited associated service revenues), strong sales of a discounted Z10 could at least give the platform a bit of life.
As a comparison, the high-end Nokia Lumia 920 has only sold an estimated 3 million units in 9 months, while the entry-level Nokia Lumia 520 has sold an estimated 4 to 5 million units in just over 3 months. It will be interesting to see whether a lower priced Z10 can similarly increase volumes.
What Does This Mean For A Potential Deal?
The results do not change the value of the patents and probably have a limited effect on the software and services valuation. It does signal that the hardware division's value is likely to be worthless at this point, likely with a negative valuation if BlackBerry is acquired whole. The results probably do not make too much of a difference to the chances of Watsa or Lazaridis making a bid. It may make it harder for them to raise money for a bid, but at the same time the cost of the bid is also reduced.
Other potential acquirers may want to wait to see how BBM uptake on iOS and Android goes, as well as the reception to an inexpensive Z10 before attempting an offer for the company as a whole. Interest in various pieces of the company (outside of the hardware division) would be largely unchanged.