BlackBerry: Don't Write It Off, Buy The Stock

| About: BlackBerry Ltd. (BBRY)

Summary

Priv sales fell short due to carrier delays.

BlackBerry 10 is being wound down.

Will the transition to Android save BlackBerry?

So many minions over the years have written BlackBerry (NASDAQ:BBRY) off. And so far they have all been wrong.

The biggest asset BlackBerry has is not its technology. It is not its enterprise business. It is definitely not its phones. It is Mr. John Chen.

Accountability and transparency are paramount when in the middle of a corporate turnaround. Mr. Chen is the perfect man for the job. He is a blend of experience, knowledge and respect. Respect, both internally and on Wall Street. Prior to coming to BlackBerry, Mr. Chen was President and CEO of Sybase. While at Sybase, he grew the company from a market cap of $365 million to over $5.75 billion. During that time he also achieved a 28% annual growth rate and over 13 years of nonstop profitability.

Many on Wall Street have written BlackBerry off as a has been. Under Mr. Chen's leadership, I think they are wrong. Not only is the business model being redefined, BlackBerry is doing so when very few people expected it. Most impressive however are Mr. Chen's comments when discussing the company's progress.

To quote Mr. Chen after Q3 2016 earnings:

I am pleased with our continued progress on BlackBerry's strategic properties, leading to 14 percent sequential growth in total revenue for Q3. We delivered accelerating growth in enterprise software and higher revenue across all of our areas of focus. Our new Priv device has been well received since it's launch in November and we are expanding distribution to additional carriers around the world in the next several quarters.

Additionally Mr. Chen commented:

BlackBerry has a solid financial foundation, and we are executing well. To sustain our current direction, we are stepping up investments to drive continued software growth and the additional PRIV launches. I anticipate this will result in sequential revenue growth in our software and messaging business in Q4. In addition, the company anticipates continuing positive free cash flow and adjusted EBITDA.

So how did Q4 pan out? Just this past Friday, BlackBerry released Q4 and full year earnings.

Below are Mr. Chen's comments regarding the software business:

We have clearly gained traction and market share in enterprise software. We more than doubled our software and licensing revenue in Q4 and exceeded our target of $500 million for the full year... There were a number of deltas when we first set this goal in November 2014. So this milestone now shows the scale and the traction that we are achieving. In addition, we landed 3,600 customer orders in Q4 giving us over 10,000 customer orders for the fiscal year FY16.

Margins, Cash Flow And Profitability

It is peculiar how all the bad news makes the headlines yet the positives are dismissed. The following was another excerpt from Friday's earnings call transcript:

Turning to margins, gross margin was 48.7%, up from 44.9% last quarter. Gross margin increased sequentially due to strong performance in software and services. The reduction in fixed royalty costs, slightly offset by low hardware volume and continued decline in SAF also helped gross margins in the quarter. Our model reflects a gross margin in the mid-to-high 40s for the next quarter.

Operating expenses were $258 million, down from $280 million last quarter. Our non-GAAP operating expenses exclude $188 million in restructuring and acquisition charges, $28 million in amortization of acquired intangibles, $17 million in stock comp expense, and a non-cash credit of $40 million from our convertible debt. As a reminder, this non-cash adjustment to the debt has no impact on the face value, on our liquidity or on our operations and cash flow. Operating loss was $21 million, largely due to amortization expense excluding acquired intangibles of $99 million. Our adjusted EBITDA this quarter which excludes non-GAAP adjustments previously mentioned was a positive $78 million. We had a non-cash tax recovery of $18 million in the quarter.

Regarding cash flow, we discover this from the 2016 SEC annual report filing:

For the three months ended February 29, 2016, the Company reported free cash flow of $6 million, which consisted of operating cash flows of $9 million, minus capital expenditures of $3 million. The Company anticipates continuing to generate positive free cash flow and adjusted EBITDA for the 2017 fiscal year.

Additionally, Mr. Chen commented:

Looking to 2017, our strategy is on track and our growth engines are in place to continue to generate above market growth in software and achieve our profitability objectives." Additionally, Mr. Chen noted: "Overall, BlackBerry's Q4 performance was solid as we made progress on the key elements of our strategy, which are to grow software faster than the mobility software market, achieve device profitability and generate positive free cash flow.

After the earnings were released Friday the stock was hammered, closing at $7.48 which was down 61 cents (-7.48%). So why did the stock get sold off after the earnings release if we are to take Mr. Chen at his word that things are going so well? Sales of the Priv were not up to expectations. The sales miss and subsequent associated revenues shortfall were primarily blamed on delays in getting carriers to sell the Priv. In the earnings call transcript it was noted that:

As planned, Priv is now available in 34 countries, up from four last quarter. Unfortunately, contract negotiations took longer than planned with certain major carriers, including Verizon. It pushes the Verizon launch out of the quarter. However, Priv continues to receive very positive review and net promoter scores.

Still, the revenue miss was what Wall Street focused on. All other positive metrics were essentially ignored.

The Priv's sales (part of the total smartphone sales) of 600,000 units last quarter were short of expectations. How many more Priv phones will be sold in the current quarter is yet to be seen, but with Priv now in 1,700 Verizon (NYSE:VZ) stores as of March, one would think it will add substantial units (and revenues) to Q1. Mr. Chen has stated that three million units are needed to break even. But what if the Priv and subsequent smartphones do not live up to BBRY expectations and they are not profitable? In my view it does not matter.

The next and final hope for BBRY's smartphone business is the android platform and the Priv (at least initially). IF the Priv and subsequent smartphones meet BBRY goals of profitability, great! If not, than we take Mr. Chen at his word the smartphone business will be exited. But is that such a bad thing? I say no! Substantial monies are being spent on R&D of the android smartphones. While we do not know exactly how much of BBRY's R&D spending is devoted to smartphones, we have created a spreadsheet with possible R&D amounts, and their subsequent bottom line effects.

Click to enlarge

While the above data is not an exact science, we have to think that smartphone R&D spending is between 25% and 75% of total R&D spending. As noted in the example, ANY reduction in R&D spending associated with the discontinuing of Priv and future smartphones is an immediate and substantial improvement in the bottom line profitability for BlackBerry.

Also, BlackBerry 10 seems to be slowly setting into the sunset. It too likely has substantial R&D dollars associated with it. The future of BBRY seems to be very fluid. And Mr. Chen seems willing to be flexible in that regard. BlackBerry has free cash flow. And free cash flow gives it options. And options are good.

Analyst Recommendations

It will be interesting to see how the analysts react in the next few weeks. Despite revenues falling short of expectations, earnings were a solid beat for the second quarter in a row. While not in love with BBRY, analysts are maintaining a wait and see attitude while exhibiting a small shift away from underperformance and hold.

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Short Interest

While still at lofty levels, it is noteworthy that 33% of the shares short BBRY have covered in the past nine months. The logical conclusion is that the shorts and hedge fund managers are beginning to believe that the worst is over, and that BBRY will likely succeed as an ongoing entity. The only question that remains is what will the new entity look like?

Conclusion

So what is the takeaway after the stock thrashing of Friday? In several of my articles I discuss the lessons that history teaches us when investing. The main lesson is buy low and sell high. Buy when no one wants them (as long as the company will likely not be going out of business), and sell when they cannot get enough. History also tells us to invest in companies that have a sound management team. Given that scenario, BlackBerry appears to finally be positioning themselves for the beginnings of a strategic turnaround that will benefit shareholders. As a result, I think that at the current share price BBRY is an attractive speculation and you can start accumulating.

Disclaimer: Investing in stocks such as BlackBerry can be risky. There is no guarantee that your investment will be safe. There is also a great likelihood that you may lose some or all of your investment. Please do your own due diligence before investing in BlackBerry or any other investment. Information provided in this article is informational and should not be the sole guide to determine if investing in the company is appropriate for you. The above are my opinions and should not be the sole purpose for initiating a trade. Always do your own due diligence prior to investing. Also remember to only initiate trades that are within your pre-defined risk parameters.

Disclosure: I am/we are 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.

Additional disclosure: My long exposure is via call options.