- BlackBerry is a fallen angel, perhaps never to return to its glory days.
- Blackberry posts a Valuentum Buying Index score of 3, reflecting our "fairly valued" DCF assessment of the firm, its neutral relative valuation versus peers, and bearish technicals.
- We prefer companies in the Best Ideas portfolio.
Investors sometimes grow fond of fallen angels. They wrongly believe that the prominent position that a company once had will return someday. They refuse to accept that the company is now fundamentally and structurally changed forever. The mounting losses and significant competition do not register. These investors believe that time is all that is needed to return a fallen company to its glorified past. In this context, fallen angels are simply dangerous. Let's examine the 'lack of' investment opportunity at BlackBerry (NASDAQ:BBRY) and evaluate the 'fallen angel' via the Valuentum style.
For those that may not be familiar with our boutique research firm, we think a comprehensive analysis of a firm's discounted cash flow valuation, relative valuation versus industry peers, as well as an assessment of technical and momentum indicators is the best way to identify the most attractive stocks at the best time to buy. We think stocks that are cheap (undervalued) and just starting to go up (momentum) are some of the best ones to evaluate for addition to the portfolios. These stocks have both strong valuation and pricing support. This process culminates in what we call our Valuentum Buying Index, which ranks stocks on a scale from 1 to 10, with 10 being the best.
Most stocks that are cheap and just starting to go up are also adored by value, growth, GARP, and momentum investors, all the same and across the board. Though we are purely fundamentally-based investors, we find that the stocks we like (underpriced stocks with strong momentum) are the ones that are soon to be liked by a large variety of money managers. We think this characteristic is partly responsible for the outperformance of our ideas -- as they are soon to experience heavy buying interest. Regardless of a money manager's focus, the Valuentum process covers the bases.
We liken stock selection to a modern-day beauty contest. In order to pick the winner of a beauty contest, one must know the preferences of the judges of a beauty contest. The contestant that is liked by the most judges will win, and in a similar respect, the stock that is liked by the most money managers will win. We may have our own views on which companies we like or which contestant we like, but it doesn't matter much if the money managers or judges disagree. That's why we focus on the DCF -- that's why we focus on relative value -- and that's why we use technical and momentum indicators. We think a comprehensive and systematic analysis applied across a coverage universe is the key to outperformance. We are tuned into what drives stocks higher and lower. Some investors know no other way to invest than the Valuentum process. They call this way of thinking common sense.
At the methodology's core, if a company is undervalued both on a discounted cash flow basis and on a relative valuation basis, and is showing improvement in technical and momentum indicators, it scores high on our scale. Blackberry posts a Valuentum Buying Index score of 3, reflecting our "fairly valued" DCF assessment of the firm, its neutral relative valuation versus peers, and bearish technical. With that said, let's dig a little deeper into the firm.
Blackberry's Investment Considerations
- BlackBerry, formerly known as Research In Motion, has fallen from grace. The company, once known for its smartphone dominance, continues to lose money hand over fist, and while it has some deep-pocketed supporters, this doesn't guarantee fundamentals will improve in the intensely-competitive mobile market. We think the company's Economic Castle is no more.
- BlackBerry faces a tough battle against Apple and Google (NASDAQ:GOOG) Android-powered phones in the smartphone race. Its future is very much in question, and flawless cash management will be critical.
- In an attempt to retain market share, BlackBerry has drastically slashed the prices for BlackBerry devices. Gross margins have tumbled tremendously, and we're unsure the firm will ever regain lost ground. The firm's revenue has dropped to less than $7 billion from more than $18 billion just a couple years ago. BlackBerry lost more than $11 per share in fiscal 2014.
- BlackBerry boasts a net cash position at this juncture and the possibility of a turnaround exists, but Apple (NASDAQ:AAPL) with its iOS ecosystem may be too much for BlackBerry to overcome. We expect the company to make significant investments in coming years, which may challenge the health of its balance sheet.
- BlackBerry is focused on the high-end and enterprise markets-two arenas where existing clients seem less interested in its products. Serving enterprise customers, particularly in regulated industries, will remain its focus for the foreseeable future.
- BlackBerry registers a 3 on the Valuentum Buying Index. We prefer companies in the Best Ideas portfolio, many of which are highly-rated with strong valuation and pricing support.
Our discounted cash flow model indicates that BlackBerry's shares are worth between $5-$11 each. The company is losing money hand over fist, and the wide range of fair value outcomes reflects a wide range of probabilities. On a fundamental basis, the margin of safety around our fair value estimate is driven by the firm's HIGH ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $8 per share stipulates that BlackBerry will survive, which is far from guaranteed, especially in the context of our projections. We think shares are merely a gamble on its survival.
Specifically, our valuation model reflects a compound annual revenue growth rate of -15.6% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of -28.2%. Our model reflects a 5-year projected average operating margin of -19%, which is above BlackBerry's trailing 3-year average. BlackBerry's business is in significant decline. Beyond year 5, we assume free cash flow will grow at an annual rate of -0.9% for the next 15 years and 3% in perpetuity. For BlackBerry, we use a 10.8% weighted average cost of capital to discount future free cash flows. Our fair value estimate is entirely dependent on BlackBerry remaining a going concern.
We understand the critical importance of assessing firms on a relative value basis, versus both their industry and peers. Many institutional money managers -- those that drive stock prices -- pay attention to a company's price-to-earnings ratio and price-earnings-to-growth ratio in making buy/sell decisions. With this in mind, we have included a forward-looking relative value assessment in our process to further augment our rigorous discounted cash flow process. If a company is undervalued on both a price-to-earnings ratio and a price-earnings-to-growth ratio versus industry peers, we would consider the firm to be attractive from a relative value standpoint. For relative valuation purposes, we compare Blackberry to peers Hewlett Packard (NYSE:HPQ) and IBM (NYSE:IBM), among others. Given BlackBerry's abysmal performance and negative earnings, there's not much to glean from relative valuation analysis. The company is in a lot of pain at present.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $8 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for BlackBerry. We think the firm is attractive below $5 per share (the green line), but quite expensive above $11 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate BlackBerry's fair value at this point in time to be about $8 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of BlackBerry's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $11 per share in Year 3 represents our existing fair value per share of $8 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements
In the spirit of transparency, we show how the performance of the Valuentum Buying Index has stacked up per underlying score as it relates to firms in the Best Ideas portfolio. Past results are not a guarantee of future performance.
Additional disclosure: AAPL and GOOG are included in Valuentum's actively-managed portfolios.