BlackBerry’s accelerating transition lands it on the Tematica Contender List
We’re adding a new name to the Tematica Investing Contender List today, and it’a one that you may have heard something about before – BlackBerry (BBRY).
As you read that sentence there is a distinct probability that you said “huh?” or something similar to yourself or the person next to you.
Yes, we said BlackBerry, as in the company that was once the dominant smartphone manufacturer until it was outflanked by Apple (AAPL) with the iPhone, which as we all know revolutionized the smartphone industry. Back in the day, we had BlackBerry’s named device and while it was ahead of the competitors when it came to email, the reality was the device had a horrible internet browser, a click wheel that made maneuvering around the screen challenging to say the least and its phone capabilities paled in comparison to other mobile phones at the time. In short, it was ripe for disruption and Apple did just that.
All of this helps explain the “huh?” reaction you likely had.
Here’s the thing, one of the traps that investors fall into is thinking things remain the same at companies. Sometimes that is true, and we’re seeing as part of the reason activist investor Nelson Peltz was gunning for a seat on the board of Proctor & Gamble (PG) – more on this is another post. In the case of BlackBerry, it has been a turnaround in the making that has spanned several years with revenue falling from $6.8 billion in 2014 to $1.05 billion for the 12 months ending this past August.
Now, this is where things start to get interesting because during that time period the company managed to not only shrink its bottom line losses from $1.99 per share in 2014, over the last 12 months it delivered EPS of $0.13. Current consensus expectations sit at $0.06 per share for the current year, rising to $0.08 next year even as revenue is forecasted to decline further. From a stock perspective, this means the shares are still uber expensive even if we back out the roughly $3.00 per share the company has in net cash. That’s one reason why the shares are only making it onto the Contender List, and I’ll share a few more before too long.
The nagging question is what is driving the bottom line improvement even as revenue is expected to fall further over the coming quarters?
It’s the transition in the business model from hardware to software services, which carry richer gross margins, and focuses on security. This transition brought BlackBerry back onto our radar screens as part of our Safety & Security investment theme. As we all know in reading the headlines, there isn’t likely to be any slowdown in the speed of cyber-attacks, and this is helping fuel BlackBerry’s transition. In the recently reported August quarter, its software services business accounted for just under 80% of overall revenue vs. 44% in the year-ago quarter. To show the power of that transition, gross margins in the recently completed August quarter rose to nearly 74% vs. 29% in the year-ago quarter. Lending a helping hand, the comparatively lower margin device business fell to just $16 million in revenue vs. $105 million in the August 2016 quarter. This accelerating transition helps explain why BBRY shares have climbed 15% over the last three months vs. 6.6% for the Nasdaq Composite Index and 5.3% for the S&P 500.
As this transformation continues, another item to watch at BlackBerry is its embedded software business, a key part of our Asset-Lite investment theme. The initial licensing focus for BlackBerry has been in the automotive industry with regard to autonomous cars. Recently Delphi Automotive (DLPH) announced that it chose BlackBerry QNX for its Centralized Sensing Localization and Planning platform, which is a fully integrated autonomous driving solution. Given our recent Cocktail Investing Podcast with Audi on prospects for autonomous cars, we know this is a development that still has several years to go until it is ready for prime time. That said, the win for BlackBerry at Delphi is certainly encouraging.
Finally, BlackBerry has had some success leveraging its licensing business, which includes software licensing, intellectual property licensing, and technology licensing. As we know given the position in Nokia (NOK) on the Tematica Investing Select List, licensing businesses tend to carry very favorable margins, but it’s also one that moves in fits and starts not a smooth, continuous line. We also know that it’s a business that takes time to convert prospects and opportunities into revenue and profits, and in the case of BlackBerry, there are others such as Qualcomm (QCOM), InterDigital (IDCC) and Nokia that have competing licensing businesses. This means we’re not apt to see leaps and bounds of improvement with this Blackberry business in a short period of time, but more likely periodic wins.
The bottom line is that BlackBerry’s transition to a Safety & Security and Asset Lite Business Model is accelerating, it has yet to really reap the rewards on its bottom line. With the shares currently trading at 142x expected 2018 earnings and well into overbought territory, we are going to place BBRY shares on the Contender List and watch for either a pullback in the shares to $8 to $9 at which they have support or signs its EPS generation is poised to accelerate in a meaningful manner over the coming quarters.
