BlackBerry (NASDAQ:BBRY) showcased the first product of its Foxconn (OTC:FXCOF) partnership on Tuesday, launching a 5-inch full-touch BB10 smartphone for emerging markets dubbed the Z3. The Z3 will debut in Indonesia, one of BlackBerry's biggest markets for smartphones, in April and retail for an unsubsidized price of $200. The company also introduced the Q20, its new QWERTY flagship smartphone aimed primarily at enterprise users that will be launched in the second half of the year. The Z3 and the Q20 are BlackBerry's first smartphones since it announced in December that it is pivoting to a new device strategy, which involves outsourcing the design and manufacture of smartphones for emerging markets to Foxconn, while focusing in-house resources solely on the high-end enterprise market. That the Z3 will launch soon in April is a good sign that the partnership is progressing well and the transition process is not being hampered by delays. We will be keeping a close eye on how quickly the companies roll out Z3 in new markets and launch new low-end phones in the coming months to ward off rising competition from local Asian players such as Huawei, Lenovo (OTCPK:LNVGF) and Xiaomi.
While it remains to be seen if the new smartphones will succeed in stemming BlackBerry's market share losses this year, the Foxconn partnership does give BlackBerry the scale to procure materials at favorable costs and play the margins game in an increasingly crowded low-end smartphone market. It also provides BlackBerry with an invaluable opportunity to rein in fixed costs, minimize inventory risk, and stabilize a loss-making arm as soon as possible, while it looks to keep its smartphone brand alive in regions where it is still quite popular. Eventually, BlackBerry plans to also transition the design and manufacture of high-end smartphones to Foxconn, as it focuses more on adding value through its end-to-end software suite of enterprise solutions and services. BlackBerry expects the Foxconn deal, as well as an ongoing restructuring drive, to help the company become cash flow neutral from operations in FY15 and profitable by FY16 (ends Feb 2016). Not burning cash on the devices front will allow BlackBerry to invest and strengthen its enterprise software offerings, not just in security but also other value-added services such as BBM.
However, the long-term potential for BlackBerry in the devices business doesn't seem to be great, as it transitions to a more enterprise-focused software model that emphasizes the use of hardware as means to drive its software sales, in much the same way as Apple (NASDAQ:AAPL) runs its low-margin App Store to support iDevice sales. We estimate that BlackBerry's devices division contributes only about 7% to our $9 price estimate for the company.
BB Looks To Tap Loyal Enterprise Niche
On the other hand, BlackBerry's services and software account for more than 40% of our estimated valuation for the company. BB10′s failure so far to generate demand in a consumer market heavily dominated by the iPhone and Android-based smartphones has left BlackBerry with few options but to double down on its enterprise niche. While BlackBerry's paying subscriber base seems to have fallen drastically from 79 million a year ago to about 55 million by the end of last quarter, the bulk of the decline seems to have come from the consumer side, especially in developed markets. We estimate that the company's business subscriber mix increased from around 40% in 2012 to 45% last year, as BB's enterprise subscriber base remained nearly flat at 30 million while retail accounted for the bulk of the subscriber defections to rival platforms. BlackBerry's turnaround plans revolve around making the most of this enterprise niche.
However, the enterprise market is changing, as IT administrators accommodate employees bringing their own devices to work (BYOD). Although BlackBerry's installed base is big, it is losing share to Apple and Samsung among the devices being sold to businesses and their employees. Globally, its business devices market share has declined from over 30% in 2010 to about 8% in three years, according to IDC. BlackBerry is therefore looking to make its services business less reliant on its hardware by providing cross-platform support with the latest version of its BlackBerry Enterprise Service, BES10. This is invaluable to large security-conscious enterprises and government organizations that want to support BYOD but are reluctant to undertake the complex process of transitioning all their devices to a different mobile device management (MDM) solution. In order to make it easier for enterprises to transition from the earlier BES5, which manages the older generation of BB devices, to the cross-platform BES10, the company plans to unify the two platforms with the launch of BES12 towards the end of the year.
Could BBM Be BlackBerry's Dark Horse?
While enterprise software and services is a more mature business that BlackBerry will look to stabilize and run for cash, where BlackBerry can potentially shoot for big growth is BBM. BlackBerry recently opened up BBM for access to rival platforms iOS and Android, and has seen a very good rate of adoption among users. The company announced in December that BBM had managed to attract over 40 million newly registered Android/iOS users in the previous 60 days. Measured on a monthly basis and including the installed base, BlackBerry had over 80 million active users in December - 60% of which used it daily as opposed to the industry average of 50%, according to John Chen. This gives BlackBerry a good base on which to work and invest resources, so as to add more BBM channels and features, and retain users by enhancing their engagement with the platform. While the company hasn't divulged any specifics about its BBM monetization strategy going forward, the CEO expects BBM to generate "reasonably good" revenues in the FY16 timeframe.
BBM's potential in the retail market was exemplified by WhatsApp's recent acquisition for $19 billion by Facebook (NASDAQ:FB). On a per subscriber basis, that amounts to more than $40 per user and translates to a $3.4 billion valuation for BBM. However, given that the service has only just been opened to Android and iOS and doesn't have the scale of WhatsApp, BBM is unlikely to attract such a high bid in the near term. Moreover, given BBM's importance as an integrated service option for enterprise, it may be a tough ask for BlackBerry's management to sell it off unless the service attracts a substantial bid. Still, the possibility of a BBM spin-off or sale down the road remains distinct, with Chen recently saying that he would consider such options if they were in the interest of shareholders. Due to the lack of visibility about BBM's stand-alone monetization potential, we do not value it separately but as part of our services division, which we estimate is worth about $2 billion given the sustained declines in paying subscriber base and service ARPU. However, if BBM continues to see strong adoption and stickiness among retail subscribers, it could attract a solid valuation from players such as Google (NASDAQ:GOOG) who are likely to be able to monetize the messaging data better. Such a scenario could lead to a significant upside over our current fair value estimate for BlackBerry.
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