On June 19, 2008, BlackBerry (NASDAQ: BBRY) stock established an all-time high at $147.55 per share, which also calculated out to a near $85 billion in market capitalization. At that time, BlackBerry leveraged its reputation for solid engineering and ironclad security features to then control roughly half of the smartphone market. By August 2014, however, BlackBerry shares had collapsed beneath $10.00, or $5 billion in market capitalization. BlackBerry managers had bled through roughly $80 billion in shareholder wealth over the course of six short years.
At current levels, conservative investors should judge BlackBerry as a value trap that is to be avoided. Recent improvements at Waterloo have emerged largely due to structuring of financial and investment transactions, rather than any real operational turnaround. A $1.25 billion convertible bond deal, in particular, has been largely keeping BlackBerry afloat.
BlackBerry Turnaround Plans Have Stalled
On August 6, 2014, research firm comScore (NASDAQ: SCOR) published its June 2014 U.S. Smartphone Subscriber Market Share report. Be advised that the title of this report was somewhat misleading, as comScore statisticians actually presented averages of data from the quarter that spanned between April and June. A quick review of the comScore information would highlight the presence of the dominant Google (NASDAQ: GOOG) Android - Apple (NASDAQ: AAPL) iOS duopoly above the mobile market. Taken together, Android (51.9%) and iOS (42.1%) systems combined to operate 94% of U.S. smartphones through the spring months. Meanwhile, BlackBerry closed out this same time frame clinging on to a mere 2.4% of this market, after having lost 30 basis points in share through the April - June quarter.
Last February, David Cotriss described a "world where people still dream of a new BlackBerry," in his rather bullish piece for CNBC. For his part, Cotriss suggested that BlackBerry would still be able to leverage its brand appeal to sell cheap phones throughout the developing world. Prior to Cotriss' submission, however, BlackBerry had already negotiated a five-year deal with Foxconn (OTC:FXCOF) to outsource hardware manufacturing and inventory management to the Taiwanese company. This Foxconn deal, of course, would limit the upside potential of transacting business throughout the very same emerging markets that bulls have identified as a BlackBerry trump card.
BlackBerry did launch its Z3 - Jakarta Edition, on May 14, 2014, as the first handset designed out of the aforementioned Foxconn partnership. The Z3 - Jakarta Edition phone, of course, was designed specifically for the Indonesian market and featured local artwork that framed a built-in search application for halal food. After Indonesia, BlackBerry also made its entry-level Z3 available in India, Malaysia, Philippines, and select African markets. The Z3 launch, however, appeared to have had little to no effect upon BlackBerry bottom line results. BlackBerry revenue declined from $976 million to $966 million, sequentially, between Q4 2014 and Q1 2015. At BlackBerry, the first quarter of 2015 ended on May 31, 2014, which was two weeks after the Z3 rollout.
Convertible Debentures Were a Lifeline
On November 4, 2013, BlackBerry issued a press release that it would be receiving a $1 billion investment out of a Fairfax Financial led consortium of institutional investors. In exchange for the cash, BlackBerry sold $1 billion in convertible bonds, and pledged to pay 6% interest on this debt. Terms of the agreement granted bondholders a seven-year window to exchange bond principal for BlackBerry stock at $10 per share. Last January, Fairfax exercised an option to take out an additional $250 million in these convertible debentures. In all, the deal may add 125 million shares of a BlackBerry balance sheet that only carried 526.7 million shares of common stock outstanding, as of the May 31, 2014 close of Q1 2015. BlackBerry shareholders are now exposed to 23.7% in ownership dilution.
Be further advised that Fairfax Financial was actually BlackBerry's most powerful shareholder, with a near 10% ownership stake in the telecommunications firm, at the time of the debenture deal closing. Steven Davidoff Solomon, in his November 4, 2013 New York Times piece, speculated that Fairfax had negotiated a sweetheart deal for itself, after talks to sell BlackBerry outright led nowhere. Solomon even went on to dismiss the "best of both worlds" convertible bond arrangement as an attempt to "save face." As a creditor, Fairfax Financial would maintain asset claims above those of shareholders, in the event of bankruptcy. Fairfax literally ushered itself towards the front of the line with the mere stroke of a pen.
The BlackBerry Q1 2015 balance sheet listed out $2.7 billion in cash and short-term investments above $3.1 billion in total liabilities. The $3.1 billion in liabilities did include $1.3 billion in long-term debt and $512 million in deferred revenue. The deferred revenue, of course, will ultimately be recognized on the income statement. Without the $1.25 billion cash infusion from the convertible bond deal, BlackBerry may have transitioned into Q2 2015 with a mere $1.45 billion in cash and short-term investments above $1.3 billion in current accounts payable and accrued liabilities on the balance sheet.
The Bottom Line
The convertible debentures were, indeed, a lifeline to preserve BlackBerry from going bust. Going forward, investors may be staring down massive inventory and property write-downs, if BlackBerry still fails to leverage real assets to turn profits. BlackBerry did headline its Q1 2015 report as a return to GAAP profitability. In all, BlackBerry generated $23 million in net income of $966 million in sales through the first quarter of its fiscal 2015. The prior quarter, BlackBerry racked up $423 million in losses upon $976 million in revenue. For the sake of comparison, BlackBerry posted $84 million in losses and $3.1 billion in revenue last year during Q1 2014. BlackBerry revenue, of course, has deteriorated sharply alongside the near collapse of the underlying business model.
Interestingly, the $1.25 billion convertible bond deal was also the primary engine of near-term profitability at BlackBerry. BlackBerry did benefit from a $669 million swing in debentures fair value adjustment through this latest quarter (Q4 2014 debentures fair value adjustment of $382 million vs. Q1 2015 debentures fair value adjustment of -$287 million = $669 million difference). This adjustment largely helped BlackBerry to reduce its operating expenses from $1.1 billion to $431 million sequentially between Q4 2014 and Q1 2015. The drastically lower operating expenses, in turn, translated into the small $23 million Q1 2015 net profit for BlackBerry.
Bottom line profitability that was largely the result of improved financial and investment activities should not be mistaken for any real and sustained business turnaround. Be advised further that quarterly operational cash flow was literally halved from $630 million to $302 million over the past year. The BlackBerry core mission, of course, emphasizes telecommunications sales, instead of trading bonds.
Conservative investors should avoid BlackBerry shares. The financial risks at Waterloo appear eerily similar to those immediately predating the credit crisis and ultimate collapse of Lehman Brothers. Floating the note through convertible bond sales is a far cry from long-term operational business health.
Disclosure: The author is long AAPL.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.