Service revenues will likely bottom out at $140 million to $243 million per quarter.
Service revenue declines will likely continue into FY2016.
Hardware sales need to stabilize above 3 million units per quarter to allow BlackBerry the opportunity to reach profitability through increased software revenues and monetizing BBM.
One question surrounding BlackBerry (NASDAQ:BBRY) is how low service revenues will fall before they bottom out. While BlackBerry is focusing on becoming more of an enterprise software company, service revenues will remain an important contributor to gross margin, and stemming the decline in service revenue is essential to BlackBerry's plan to become at least cash flow-neutral by FY2016.
Service revenue in Q4 FY2014 declined to $548 million from $632 million in Q3 FY2014. This is a 13% decline, and service revenue is expected to decline by a similar amount in Q1 FY2015, which would put it at $477 million for that quarter. If you include BlackBerry's deferred service revenues from Argentina and Venezuela, that would have increased its base amount to $591 million for Q4 FY2014 (adding $53 million in deferred revenue, and subtracting $10 million in previously deferred revenue that was collected in Q4 FY2014). However, it is uncertain whether BlackBerry will be able to collect/recover service revenues from those countries in the future.
Estimating Future Service Revenues
Here's a look at how service revenues per subscriber per quarter have evolved over the past couple years. Subscriber numbers for Q2 FY2014 to Q4 FY2014 are estimated based on past trends, where sell-through of 9 to 10 million was required for BlackBerry to maintain its subscriber base.
Service Revenues ($ Million)
$ Per Sub Per Quarter
One way to estimate the low point of future service revenues would be to take the sell-through of 3.4 million units in Q4 FY2014 and use it as a base. Sell-through of 3.4 million units per quarter would translate into roughly 27 million subscribers, based on an average life cycle of two years. At $9 per subscriber per quarter, this would equal approximately $243 million in service revenues per quarter. The service revenue per subscriber per quarter was approximately $11 in Q1 2014 (based on reported service revenue, and not including the deferred service revenue), but that has declined to an estimated under-$10 per subscriber per quarter now. The decline is due to there being 4 to 5 million BlackBerry 10 users now, of which only some enterprise users would be providing service revenues. The proportion of BlackBerry users that do not provide service revenues is expected to increase going forward.
If sell-through declines to 2 million units per quarter, then service revenues would be an estimated $144 million, based on 16 million subscribers.
A second approach would be to assume that BlackBerry 7 sales continue to fall to around one million units per quarter (currently at 2.3 million), resulting in eight million subscribers, based on an average life cycle of two years. At $9 per consumer BlackBerry 7 subscriber per quarter, this would equal approximately $72 million in service revenues per quarter. Approximately 20% of subscribers are enterprise customers, so assuming that 0.7 million units per quarter are enterprise sales results in 5.6 million subscribers, based on the same average life cycle of two years. At $25 per enterprise subscriber per quarter, this results in $140 million in service revenue per quarter. Combining the two results in an estimate of $212 million in service revenue per quarter. BlackBerry is still selling BlackBerry 7 devices for the foreseeable future, but if/when that is eliminated, consumer service revenues will dwindle to zero, leaving just the enterprise portion.
So depending on what happens with future sales trends (especially with BlackBerry 7), we would expect anywhere from around $140 million to $243 million in service revenue per quarter as the low point for BlackBerry service revenues.
Service revenues have 84% gross margin, according to BlackBerry's annual filing. Therefore, the service revenue gross margins should bottom out at $118 million to $202 million per quarter, depending on unit sales.
If the average ASP is $300 per unit with 20% gross margins, then hardware should contribute $120 million to $204 million to gross margins per quarter. This assumes that the new Bold manufacturing deal and the Foxconn (OTC:FXCOF) contract help push hardware margins back up to that 20% mark.
Software gross margin is left at $50 million per quarter for now, and the other category has been left out, since it is pretty negligible.
GM In $ Millions
2 Million Units
3.4 Million Units
Total Gross Margin
With operating expenses at roughly $600 million per quarter, this means that if sales decrease to 2 million units per quarter, BlackBerry will need approximately $300 million in extra gross margin per quarter from increased software sales and other items to break-even when service revenues fall to its floor. If sales stay at 3.4 million units per quarter, BlackBerry will need approximately $140 million extra in gross margin per quarter to break-even.
Service revenues are likely to bottom out at between $140 million and $243 million per quarter, depending on how hardware sales go. At that point, BlackBerry will need to generate approximately $140 million to $300 million extra in gross margin per quarter from increased software revenues, QNX, BBM, etc... in order to break-even. Obviously, if hardware sales increase, the gap will be much smaller or negligible.
BlackBerry appears to need hardware sales to remain at 3 to 4 million units per quarter to make break-even fairly achievable when service revenues bottom out. Although BlackBerry is becoming more software-focused, it still needs to stabilize hardware sales for a strong chance at break-even at current operating expense levels.
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. I own some 2015 BlackBerry calls. Also have a short position that I started in February and am closing out. Probably would characterize my stance as cautiously long at this point although that is subject to change depending on valuation.