BlackBerry: Let's Make A Deal

Sep.23.13 | About: BlackBerry Ltd. (BBRY)

So much for Friday, September 27th. That was an important day I had circled on my investment calendar. That was the day that BlackBerry (NASDAQ:BBRY) was expected to release its fiscal second quarter results. Just a few weeks ago, I wrote an article describing how this quarter was likely to be ugly. I expected BlackBerry shares to tumble on the news, but told investors hedging a short position could also be wise just in case there was some large positive announcement made in addition to the earnings report.

Well, we couldn't even reach September 27th without bad news coming out. On Friday afternoon, BlackBerry issued a massive revenue and earnings warning, sending shares 17% lower for the day after rallying off their lows. At this point, BlackBerry as we know it is done. There is no point anymore in holding on to the hope that BlackBerry 10 will save this company. With this company putting the last nail in their coffin, it is time for this company to make a deal.

The large warning:

The company announced for the second quarter that they would be recording revenues of approximately $1.6 billion. The company is only recognizing smartphone sales of 3.7 million for the quarter. Here is their explanation of the revenue shortfall.

The Company currently expects to report revenue for the second quarter of approximately $1.6 billion, of which approximately 50% is expected to be service revenue. For the second quarter, the Company expects to recognize hardware revenue on approximately 3.7 million BlackBerry smartphones. Most of the units recognized are BlackBerry 7 devices, in part because certain BlackBerry 10 devices that were shipped in the quarter will not be recognized until those devices are sold through to end customers. During the second quarter, approximately 5.9 million BlackBerry smartphones were sold through to end customers, which included shipments made prior to the second quarter and which reduced the Company's inventory in channel.

It really doesn't matter at this point how many phones they sold. All you really need to know is the number was bad. The company also said that approximately 50% of their revenues were expected to be service revenues, so an extra million or two phones wouldn't have made a huge difference. Analysts were looking for $3.06 billion in revenues, so the company widely missed on the revenue front.

The company also announced it would be taking two large charges. The smaller charge was a $72 million pre-tax restructuring charge. The larger and more important one was a $930 million to $960 million charge that essentially is an inventory write-down. The company is taking this charge because of the competitive environment that has pushed sales well below projections. They have too much inventory and supply commitments, so they have to take the charge.

The company expects an adjusted loss of $250 million to $265 million, or $0.47 to $0.51 per share. Analysts were looking for an adjusted loss of $0.16, but I don't think it is a surprise to anyone that there's a miss here given the revenue issue. After all of the charges, the company is expecting a GAAP loss of $950 million to $995 million, or $1.81 to $1.90 per share.

Business restructuring:

BlackBerry also announced a significant restructuring of the entire business. The company is targeting a reduction of 50% in operating expenses by Q1 of fiscal 2015, which ends in May 2014. As part of this plan, the company will eliminate 4,500 positions, close to 40% of their workforce. After this transition, they will have approximately 7,000 full-time global employees.

Additionally, the firm will be transitioning its future smartphone portfolio from six devices to four. They will focus on enterprise and prosumer-centric devices, including 2 high end and 2 entry level devices in all-touch and QWERTY models. CEO Thorsten Heins provided the following statement in regards to the restructuring:

"We are implementing the difficult, but necessary operational changes announced today to address our position in a maturing and more competitive industry, and to drive the company toward profitability. Going forward, we plan to refocus our offering on our end-to-end solution of hardware, software and services for enterprises and the productive, professional end user. This puts us squarely on target with the customers that helped build BlackBerry into the leading brand today for enterprise security, manageability and reliability."

Other items of note:

The company stated that adjusted gross margins would be in the 35% to 37% range. This would mark an improvement over the Q1 figure of 33.9%, but would be lower than the 40.1% value from Q4. In last year's period, gross margins were 26%, so this year's value would mark a sizable improvement.

Another important item is the company's cash and investments balance. BlackBerry's cash pile has been one of the items BlackBerry bulls have focused on, as the cash pile has represented a significant portion of the market cap of this name. Bulls have said that the large cash pile will allow this name to remain competitive, or help this company fetch a decent acquisition price. Unfortunately, the cash pile decreased in Q2, and quite substantially. BlackBerry reported a cash pile value of $2.6 billion, down from the $3.1 billion we saw in Q1. That equates to a loss of about $1 per share in cash during the quarter. We'll get the exact numbers later this week, but it will be a sizable decline. A decline was expected, but analysts will need to ask if the company expects to burn through more cash in future quarters and how much. BlackBerry's market cap as of Friday's close was $4.50 billion, so the cash pile still represents a sizable amount of that. The cash pile may be large, but it certainly isn't helping the company.

Potential deal makers:

BlackBerry as we know it is done. Those that thought BlackBerry 10 would be the complete savior of this firm and bring it back to relevance need to give up now. This company is not competitive anymore, and if the nearly billion dollar inventory charge does not prove that, I don't know what will. It's time to make a deal, and BlackBerry stated in the press release that strategic alternatives are still being examined. At this point, either the company as a whole could be sold, or maybe just some pieces like Nokia (NYSE:NOK) recently did. There are five potential suitors that are always discussed, so I'll break them down here. They include Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN), along with the potential go-private option. I discussed in my above mentioned BlackBerry article how the go-private option was having trouble gaining traction, although the emergence of a new player could make things interesting.

I'll start with Amazon and go alphabetically. The rumors have always been out there that Amazon is going to launch some sort of phone eventually. Recently, there were reports (since negated) that the company would even give it away for free. BlackBerry would fit in perfectly for Amazon. Amazon would be able to expand its revenue base, with very low or negative margins. That's been Amazon's recent strategy, so what would be different about this? The one caveat here is that of the four companies I mentioned, Amazon has the least financial flexibility. Amazon had just $7.5 billion in cash and investments on the balance sheet at the end of their Q2 period. That's the smallest balance, meaning an Amazon-BlackBerry deal would probably need Amazon to take out some sort of debt or finance part of it with equity.

Apple will always be thrown in because it has the most money, so an acquisition would be financially easiest for them to swallow. Apple had more than $146 billion in its cash pile at the end of its most recent quarter, of which about $106 billion was located outside the US. Apple could easily swallow up BlackBerry, although Apple has not been known to make many large (multi-billion dollar) acquisitions. The interesting item for BlackBerry in regards to Apple is the emerging markets aspect. When Apple recently launched its new phone line, there were a number of complaints regarding Apple's phones being priced too high. Many argued that Apple has not properly addressed emerging markets, so a purchase of BlackBerry could help with that. The question is would Apple be able to hold up its margins there, which is why I think they will slowly ease into emerging markets themselves rather than jump in very quickly with an acquisition.

Google is another name with a large cash pile and high interest in this space. Google made a large acquisition, completed in 2012, of Motorola Mobility. Low-end Android devices targeting emerging markets are one reason why BlackBerry has struggled, so how exactly would this work? Would Google make a further push into this market, or would they just acquire BlackBerry to eliminate a competitor? Google could also use this acquisition as a way to just steal more market share. Google clearly has the money to do so, with more than $54 billion in cash and investments at the end of their Q2 period, of which about $20 billion is located inside the US.

Microsoft is an interesting name to consider here as well. Microsoft recently announced the acquisition of Nokia's devices and services business. You would think that Microsoft would not try to acquire another device maker in this situation. However, if Microsoft were to buy BlackBerry as well, they could really combine units into an all-in-one type segment. Prior to the Nokia acquisition, Microsoft had about $77 billion in cash and investments on its balance sheet, of which $70 billion was foreign based. You would think the Nokia deal would eliminate Microsoft from the BlackBerry sweepstakes, but Microsoft has never been one to shy away from large purchases.

Final thoughts:

The launch of BlackBerry 10 has not been the savior many were looking for. The Canadian device maker is done in current form, and it is time to move onto the next chapter. Will that be a Nokia like segment sell off, or a sale of the entire business? That remains to be seen. One thing is sure. The company cannot exist as is, which is why I still am calling this a short candidate. I do think a deal eventually comes, but when that occurs is unclear, so there could be plenty of pain until that point. We could see another large loss on Friday when management holds BlackBerry's funeral, otherwise known as its conference call.

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: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.