Crunching The Numbers: BlackBerry Severely Undervalued

| About: BlackBerry Ltd. (BB)
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BlackBerry (BBRY), the battleground stock du jour, is the target of sensationalistic headlines on a daily basis as vested interest from both sides battle it out. Hardly a week goes by without seeing yet another title with a variant of "too little too late" or "dead company walking" etc., etc. Let's face it, it's all getting a little cliché.

The press has been calling for the company's demise for almost two years, but it is still alive and kicking. Many analysts and writers have got it so wrong and have ignored basic mathematical facts for so long that it would be comical if the stakes weren't so high. We can expect these baseless conjectures to continue and the headline battle to heat up as we approach the moment of truth sometime in March - when the company releases hard numbers.

But the fact of the matter is, we don't operate in a pure speculative vacuum anymore. There is already enough empirical evidence out there now for us to start making some reasonable guesstimates: The next generation BlackBerry Z10 devices are out in many markets, early sales indicators are in, we know what the ASP is in various markets and carriers, and we know approximately how much it costs to make a Z10, so we can start taking a stab at the gross margin.

It's about time for some intellectual honesty. Get off your lazy butts, sharpen some pencils and do some real financial analysis. I challenge both sides to crunch some numbers and start making rational, numerical arguments with reasonable assumptions rather than trying to grab page views with polarizing headlines.

My approach is very simple. To be safe, I have erred as much as possible to the side of pessimism in my analysis. But even with this conservative approach, the results are staggering - the elephant in the room is that BlackBerry does not need to sell anywhere near as many units as iPhone or Android to be immensely successful financially.

Even with conservative assumptions, the results are so unbelievable that I encourage my readers to rip this analysis apart and call me out on any mistakes.

I'll share the results with you first and then work back to justify the key assumptions:

Actual Possible Scenarios
Q3 Annualized

Best Case:

IDC 2015 Prediction (14% Market Share)

Median Case:

10% Market Share

Worst Case:

No Improvement over BB7 (4.5% Market Share)

Key Assumptions
BB10 Units Shipped 0.0 101.1 72.2 32.5 Assuming no growth in global smartphone market (2012: 722.4M units sold)
HW Gross Margin ($) 0.0 15170.4 10836.0 4875.0 Z10 has lower cost than Lumia 920 and around the same ASP, but to be conservative, we'll use the same margin contribution at 150/unit. Also assuming $0 margin for BB7 units so those sales are ignored
BB7 Subscribers Remaining 79.0 28.4 42.9 62.8 50% of new BB10 sales cannibalize existing BB7 subscribers
S&S Revenue 4363.2 1570.3 2368.3 3465.7 Software & Services fall assuming $0 S&S from BB10
S&S Gross Margin ($) 3320.0 1194.9 1802.0 2637.1
Operating Expenses 4240.0 5240.0 5240.0 5240.0 Conservatively ignore all additional savings from their "CORE" program, and add 1B for launch-related costs
Operating Income -920.0 11125.3 7398.0 2272.1
Taxes -904.0 2558.8 1701.6 522.6 Tax rate of 23% as of the last profitable year (FY 2011)
Income After Tax -16.0 8566.5 5696.5 1749.5
EPS 0.0 16.3 10.9 3.3
Target Price 163.5 108.7 33.4 10x P/E

Unit Sales

First, the most unpredictable variable is unit sales. For this reason, I have created 3 scenarios which should cover the range of probable outcomes.

IDC recently predicted that BlackBerry will have 14% market share in 2 years, which, if it comes true, will value BBRY shares at $163.5. For the sake of caution, I am using this IDC estimate as the best case scenario in the analysis.

The median case scenario I used was 10% market share. Even if BlackBerry 10 does not outsell the iPhone or Samsung (OTC:SSNLF) devices, it is certainly imaginable that 1 in 10 new smartphone sold will be a BB10 device, and anecdotal evidence so far supports this scenario, which sits between IDC's estimate and BlackBerry's 2012 market share.

For the worst case scenario, I've assumed that BB10 does absolutely nothing to improve the situation over BB7. This is a ludicrous claim given that early indicators tell us the Z10 blew past all records previously held by older BlackBerry devices. But I've included it anyway for argument's sake.

In all 3 cases, I assumed there will be no more growth in the global smartphone market, thus I have re-used IDC's 2012 estimate of 722.4M smartphones sold as the denominator to come up with a units shipped number for BlackBerry's market share. This is yet another conservative assumption, given that actual Q4 2012 shipments grew by 70.2%.

Gross Margin

According to an independent report on Nokia (NYSE:NOK) Lumia, the Lumia 920 has ASP of 338 euros, bill of material (BOM) of 163 euros, and gross margin of 34.9% after adding in non-material costs. This gives margin contribution of 118 euros or approximately $150 per unit.

We now also know that the BlackBerry Z10's BOM is around $154, significantly less than the Lumia 920; and the unlocked retail price of Z10 is around $600-700, comparable to Lumia. So we can reasonably expect the Z10's gross margin to come in higher than Lumia's, most likely at $200 per unit or better.

However, for the sake of being conservative, I have applied Lumia's margin of $150/unit into the above analysis for BB10.

Software and Services

BlackBerry CEO Thorsten Heins made it known in its Q3 earnings conference call that the BB10 operating system will no longer require special BIS plans to operate. This will have a direct negative impact on BlackBerry's service revenues on devices sold to the consumer segment.

But all was not lost. Most of the corporate BES fees will remain, and in the long run, BlackBerry should be able to replace lost revenue with new services, not to mention the on-going software revenue coming from their QNX division.

Despite all this, I have taken the conservative approach of completely writing off all service revenue from BB10 devices. I have also assumed that 50% of new BB10 devices sold will cannibalize existing BB7 subscribers, and thus reducing the associated BB7 service revenue to $0 for those subscribers.

OpEx and Other Items

For operating expenses, I have ignored any further savings from BlackBerry's ongoing "CORE" initiative (despite the program's success in controlling costs over the previous few quarters). Also, I have tacked on an additional $1 billion of BB10 launch-related costs.

I have used a 23% effective tax rate, taken from their last profitable fiscal year.

This company has no debt, so interest expense (if any) is negligible.

Bottom Line

Despite taking a deliberately conservative approach, it is clear that BlackBerry is still absurdly undervalued under all probable scenarios. I encourage readers to run some numbers themselves using their own assumptions and see if the same conclusion can't be reached.

Based on the 3 scenarios and a 10x P/E, the fair value of BBRY ranges between $33.4 to $163.5 per share, or roughly 135% to 1055% return from the current price. Some readers may want to adjust the P/E assumption down to 7x to 8x but the general conclusion will remain the same: BlackBerry is a definite BUY.

The math shows that odds are severely skewed to the upside for BlackBerry. Investors who can open up their eyes to the economics behind this business and tune out the daily non-sense spewing from the media will be immensely rewarded.

Disclosure: I am 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.