Shareholders in BlackBerry (NASDAQ:BBRY) have been frustrated by the company's flagging sales and disappearing profits as the iconic smartphone seller struggles to compete against "sexier" touch screen handsets. BlackBerry management has met the challenge with a two-pronged strategy. The first prong is a restructure by divesting real estate to convert hard assets into cash and reducing personnel to save on operating expenses. I discussed the sale of real estate as one element of this restructuring in Part I of this three-part series.
The second prong in BlackBerry management's scheme is to return to its core strength: providing enterprise customers with highly secure communications devices and services. It is a tough business with plenty of muscle flexing by a host of competitors who covet the enterprise customer's wallet and consider security THEIR bailiwick.
Does BlackBerry have any muscle to flex and, if so, what is the value of that force?
Many investors might expect a detailed discussion of the personal communications market with long-winded comparisons of features with competing devices and services. While that line of investigation is certainly valid, it is a discussion for someone else's article. I'm going to stay focused on BlackBerry's assets - both on and off the balance sheet.
Starting first with BlackBerry's most liquid assets, we know the company had $1.6 billion in cash at the end March 2014, with another $950 million in short-term marketable securities. The $278 million check that BlackBerry will receive from the sale of its Canada real estate seems like a drop in the bucket by comparison. As impressive as BlackBerry's cash might be in magnitude, in my view the cash balance is not pivotal in terms of value generation. Having ample cash simply provides breathing room for a company with unprofitable operations that require support.
Asset Writedown: Hold Up There!
The second largest asset category on BlackBerry's balance sheet is intangible assets. A small portion of these assets are related to customer lists, patented technology and other trappings of businesses that BlackBerry acquired over the years, including Paratek Microwave in 2013. The majority is intellectual property that BlackBerry has licensed to third parties. In the most recently reported fiscal year BlackBerry hired some very smart asset appraisers who sharpened their pencils and figured out the value of the company's intangible assets were not supported by estimates of future revenue and income. Accordingly, the value of intangibles was reduced by $1.9 billion, leaving $1.4 billion intangible assets at the end of March 2014.
Most investors, who saw this write-down unfolding probably thought this was a damning, but fair, indictment of BlackBerry's market prowess. It certainly does not evoke an image of a company with the muscle thought necessary to compete with larger more developed mobile phone handset and wireless service providers. Lower value of intellectual property translated directly into lower market value of stock.
Hold up there! Please note how those appraisers came up with their conclusion. The company's 2014 annual report explains, "The licenses that were written down to fair value related to the LLA (Long Lived Assets) Impairment Charge were valued using a volume ratio approach incorporating unobservable inputs." Reliance on "unobservable inputs" is a bit troubling for me as an analyst, because I know I can reach out into the ether and come up with a wide range of generally plausible numbers that could swing intangible asset values by millions.
Intangible Assets Revisited
Instead, let's use some common sense about the assets BlackBerry needs to compete effectively as well as the meaning of this accounting treatment called a "writedown." Yes, the proprietary technology and intellectual property that have been discussed in the preceding few paragraphs are central to future sales and earnings. All the writedown action tells us is that a revised valuation of the assets based on a new rendering of future sales and earnings is not as great as the value shown on the balance sheet. It could have been triggered by changes in assumptions related to usage rates, concerns about future profit margins or worries about technology changes.
The magnitude of the 2013 writedown of BlackBerry's intangible assets was based on one of potentially many plausible sales and earnings scenarios. No doubt BlackBerry's various advisors had strong reasons for their final choice, but it is likely they chose the most conservative in order to avoid embarrassment in the future. After all, what harm could come from a writedown when potential expenses no longer trickle down to the bottom line in the form of depreciation expense? If fortunes reverse, the company could start making money again - this time hand over fist, with no amortization impact on net income. Note that once impairment has been recognized under U.S. GAAP the old values cannot be restored.
A host of financial performance metrics can improve after an asset writedown. Besides higher operating profit margins that accompany lower amortization expenses, returns on assets and equity will improve on higher income. Lower asset values mean a reduction in equity, but now the debt-to-equity ratio will be lower. It seems management just cannot lose with a writedown - at least in terms of financial performance measures.
In the meantime, the "assets" - invisible to the eye as they are - remain in play and at the disposal of BlackBerry engineers and salesmen from one day to the next. The company can keep on using its technology and know-how without interruption. The cumulative savvy of its messaging service, the software guiding its network, and configuration of BlackBerry's iconic keyboard, among other intangible assets, all remain available to the company.
Notice that despite the writedown BlackBerry is still able to defend itself, as well as press its own claims in court as it relates to patented and proprietary technology. BlackBerry offers a laundry list of claims and counterclaims, including a misunderstanding with Cypress Semiconductor that had the two companies filing claim and counterclaim one after another since 2013, arguing over the intricacies of connecting of peripheral devices to a computer and USB charging. There is also the more recent lawsuit BlackBerry filed against Typo Products over use of the BlackBerry keyboard.
Stay Tuned for Part III
The lawyers and accountants have a different view on the viability of BlackBerry's intellectual property. The lawyers certainly seem to think BlackBerry has plenty of muscle to defend itself in court even if the accountants measure the company's muscle by a different (and shrinking) yardstick. What really has me wondering about value is what is not on BlackBerry's balance sheet. In Part III of this series we take a look at what could be called "off-balance sheet" assets.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.
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.