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Summary

  • Discussions about QNX's prospects for generating attractive top line growth for BBRY can't be just based on descriptive arguments, they should provide valuations with reasonable assumptions.
  • On a stand-alone basis, even with the most optimistic valuation assumptions, QNX only accounts for a mere fraction of BBRY's current market cap.
  • However, a stand-alone valuation fails to take into account the potential for synergies and ancillary revenue.

Motivation

Making money on BlackBerry (NASDAQ:BBRY), either in a long or short position, at the end of the day depends on the probability of success of specific events. If you read long or short BlackBerry authors on SA, you will find that there are some valid arguments on both sides of the table. However, I find that valid arguments seldom transcend into investing profits on a risk-adjusted basis if they omit an attempt to value the business and describe the underlying assumptions.

Two of the most consistently made arguments for BlackBerry's rise from its ashes are BBM's and QNX's monetization potential. In this article, I will focus on QNX.

Although there are a number of great articles on BlackBerry in SA, I still haven't read any serious attempt at assessing QNX's value while making transparent assumptions. In this article, I try to close that gap.

Longs' Take on QNX

There is no doubt about QNX dominance on certain embedded software markets, such as automotive infotainment, where its market share could be north of 50%. The presence of QNX in other fields such as healthcare, industrial and defense could also be quite dominant (although I have never seen market share estimations of QNX in those markets).

I have no doubt that the Internet of Things (IoT) will continue its trend upwards and that QNX is poised to grow on its back. Cisco (NASDAQ:CSCO) estimates that the number of connected devices will grow at a CAGR of approximately 17% from 2010 to 2020, reaching more than 50 billion devices.

QNX's latest run has been spectacular, including its new agreement with Ford (NYSE:F), which dropped Microsoft (NASDAQ:MSFT) as its infotainment embedded software provider, and its agreement with Apple (NASDAQ:AAPL) to support CarPlay (which could indicate Apple's lack of know-how or interest to compete with QNX).

Shorts' Take on QNX

While there is no denying the growing user base of QNX, assessing its revenue potential is problematic given BlackBerry's lack of transparency on this particular item. Before entering into the monetization potential, let me first attempt to describe the embedded software industry.

The embedded software industry is characterized by an intense competition and great negotiating leverage of a small number of clients. The industry is labor-intensive, and lacks significant barriers to entry. Let me expand on this.

Intense competition. QNX is based on UNIX, open -source software. Open-source software's public and collaborative scheme poses a challenge for any company attempting to create and monetize proprietary software based on open sources. Any group of programmers, including former employees of established companies, could build upon open-source software and create competitive products, either on a public basis or through proprietary software. QNX's competition includes Mentor Graphics (NASDAQ:MENT), Sysgo AG, Intel (NASDAQ:INTC), HP (NYSE:HPQ), IBM, Accenture (NYSE:ACN), Microsoft and many others. In general, there are a small number of pure embedded software companies. Most companies are either acquired by potential customers, such as Intel's acquisition of Wind River Systems to support its microprocessors or even BBRY's acquisition of QNX to power its smartphones and tablets, or internally developed as a subsidiary.

Small number of clients in concentrated industries. QNX clients include big companies in consolidated industries, such as Audi, BMV, Caterpillar (NYSE:CAT), Chrysler and Cisco. Even the nature of its software offer poses a challenge for generating revenue. If, for example, QNX develops infotainment software for BMV, it should be clear that Caterpillar has little use for it, which increases BMV's negotiating leverage over QNX. Having a few big customers in relatively concentrated markets (think nuclear power plants) leaves any company in a weak position to press its clients on pricing.

The results of these industry characteristics is translated into cheap licensing fees agreements, due to small pricing power, and little revenue.

An Attempt to Value QNX

Since BlackBerry won't disclose QNX's revenues, I provide estimation based on how much money it generated while still in the hands of Harman International Industries (NYSE:HAR) (former owner of QNX).

2007200820092010E2011E2012E2013E2014E
Revenue (million)3341374551566269
Growth 23%-10%24%11%11%11%11%

*For 2007-2009, I use Harman's 10-K for 2007, 2008, 2009 and 2010 available at Edgar; for 2010, I annualize the 1Q10 revenue.

Harman International Industries, whose infotainment and household audio divisions accounted for most of its revenue in 2013, bought QNX in 2004 for $138 million. But it wasn't until later that it began to disclose QNX's revenue on a separate basis. From 2007 to 2009, QNX registered sales of $37 million, on average. On June 2010, BlackBerry bought QNX from Harman for $200 million. BlackBerry records QNX's revenue in "Software" and "Services". Nevertheless, given BlackBerry rapid decline on all categories of revenue, it's difficult to assess QNX's contribution, although management -on the MD&As- points to QNX's growing revenue as an offset to the general decline in sales. To estimate its revenue, I first annualize QNX's 1Q10 $11.4 million sales while still under Harman. I then optimistically assume that its revenue increased in line with its CAGR of the period 2007-2010 (11%), reaching almost $70 million by 2014.

To estimate further top line growth, I turn to Cisco's forecast of 17% CAGR in the IoT industry for the period 2010-2020. By this account, QNX's revenue could reach $175 million by 2020.

Since I don't have numbers for QNX's EBITDA, margins or bottom line, I use the price-to-sales ratio to attempt to reach a reasonable valuation.

First, note that some sources estimated QNX's revenue in 2004 of $25 million, which would indicate that Harman's acquisition was priced at 5.5x. BlackBerry's acquisition is actually lower, using my estimate for 2010 revenue, at 4.4x.

Selecting the correct comparable public companies for QNX is a challenge. Some companies' embedded software revenues amount to a negligible portion of their total top line, such as Microsoft. Others' main objective in owning an embedded software subsidiary is serving their own hardware, operating an integrated business, like Intel. As noted earlier, only a handful pure embedded software companies exist in public capital markets. I chose Mentor Graphics, Cadence Design (NASDAQ:CDNS) and Synopsys. Mentor Graphics is mentioned by BlackBerry in its 10-K as a competitor of QNX, while Cadence and Synopsys are mentioned by Mentor Graphics as its competitors.

CompanyPrice-to-Sales ratio
Mentor Graphic2.0
Cadence Design2.9
Synopsys2.9
Mean2.6
Median2.9

*As of 28/04/2014, Source: Yahoo Finance, with my own calculations.

On the one hand, the price-to-sales ratio of these companies is substantially lower than the acquisition ratio of QNX, both under Harman and BlackBerry, which would indicate that they overpaid for QNX, or that QNX has a greater growth potential, or maybe both.

On the other hand, given QNX's potential to generate revenue through consultancy services, in addition to licensing fees, a comparison with Tech Consulting companies would result in more favorable valuations.

CompanyPrice-to-Sales ratio
Red Hat Inc.6.8
Accenture1.6
Tata Consultancy5.3
Mean4.6
Median5.3

*As of 28/04/2014, Source: Yahoo Finance, with my own calculations.

In particular, Red Hat (NYSE:RHT) provides an interesting case study. This company uses an open-source software development model, and generates revenue by producing tailor-made functionality enhancements and support for specific enterprises' needs.

QNX offers relatively low licensing fees. But that doesn't mean that it can't be properly monetized. In addition to providing embedded software, QNX has the potential to generate revenue from support, consulting and offering functionality enhancements as needed. The following chart provides a valuation range based on the price-to-sales multiple, taking into account a range between 2x and 6x and my estimate for sales during 2015.

Revenue 2015E (million): 81
Price-to-Sales ratio
2162
4323
6485

Even using the most optimistic ratio assumption (6x), QNX's valuation would stand at $485 million. Indeed, a great addition of value considering that the company was bought for $200 million. However, it would only represent approximately 12% of BlackBerry's total market capitalization.

QNX true potential: Ancillary revenue

In my opinion, if QNX is to seriously help BlackBerry to return to a glimpse of its former glory (and provide a nice return for current longs) and support a market capitalization of $10 billion or more, the company needs to generate revenue from its hardware division. I'm convinced that here lies the great potential of QNX for BlackBerry. Some of the mistakes that shorts make when estimating QNX's risk-reward equation is ignoring its ability to generate ancillary revenue for BlackBerry.

Take, for example, the recent investment in NantHealth. John Chen announced the intention to develop a new smartphone "tailored to the needs of the healthcare sector". Custom-made hardware for specific industries, a field with little competition if they are capable of developing a truly original product that addresses its specific client needs, could generate great profits for BlackBerry.

Similar hardware-software products for mission-critical industries, embedded with QNX's powerful and secure offering, could position BlackBerry to compete with IBM and its peers in niche markets. Unfortunately, more disclosure is needed in order to provide some sense of valuation for these synergies.

Source: BlackBerry's QNX: Crown Jewel Or Royal Flop?