Description

We own BlackBerry stock because we think the company is worth between $8.50 and $9.00 per share dead and, 2X to 3X that if CEO John Chen is reasonably successful.  We can think of no better executive to be running BlackBerry than John Chen. 

 BlackBerry is More Than John Chen

 BlackBerry’s fall from grace was heralded for years. The company gave away a high value product (software) to sell commodities (handsets.)  Then its commodities were no longer competitive.  Expect John Chen and BlackBerry’s new management to do the opposite.  

 We followed Sybase while John Chen repaired that company and think highly of them.  Just the same, BlackBerry has a different set of problems.  Switching away from Sybase’ software was expensive.  Buying new iPhones, Androids, instead of Blackberries is in the budget.  Look for Chen to emphasize BlackBerry Enterprise Server (BES) as the company’s backbone.  In other markets, like handsets, we think his decision making will be more rational than BlackBerry has been in the past. 

 We see Chen sitting on a valuable set of assets and opportunities.  Our low valuation (or rapid liquidation) implies a stock price of $8.65.  Our better case anticipates a “right ship” and several milestones met within the next two years.  It suggests a price target in the low $20s. 

Today’s Value/Downside Protection

At $7.29 per share, BlackBerry looks as if it is selling for about 18% less than its liquidating value.   The primary asset is BlackBerry’s BES business.  An auction with giants competing, could make our estimate look small. 

Theoretical Upside (two years out but trying to be reasonable)

 This is my attempt to do a “sum of the parts” analysis as someone in the sell side is likely to do in 2015.  Obviously it assumes the company pretty much works out but does not knock the cover off the ball. I am least certain of BBM’s separation value as it is integral to other products and may not appear on its own.  Conversely, BBM would enhance the growth rate of the other businesses and probably more than offset its separate value. 

Major Segment Valuations

BlackBerry Enterprise Server $2.0/$8.0 B

We see BlackBerry Enterprise Server (BES) much like Toyota rebounding from the unintended acceleration – slipping car mat fiasco.  The old BES (release 7 and before) was very good but only with BlackBerry handsets.  The company’s current product, BES 10 is a fiasco.  It addresses iOS and Android but needs BES 7 to manage BlackBerrys.  Two data stores, two consoles, two sets of rules makes no sense within an enterprise.  The company states BES 12 will address this and other issues.  We will be watching for progress in the form of BETA shipment announcements, enterprise adoption, and firm production ship dates.  Right now BES 12 is due in October or November, with John Chen suggesting November is more likely. We see BES as the fulcrum of BlackBerry’s future and as the business John Chen knows best. 

 Counting all BES releases, the company claims there are 80,000 “logos” or businesses running BES.  These are separate identifiable businesses but often within the same enterprise.   We estimate this translates to 4,000 to 5,000 enterprises.  On top of this there are untracked, we estimate in the tens if not hundreds of thousands or millions of small businesses using the less functional and zero cost BlackBerry Express Server. 

 As of March 28, 2013, the company claimed 33,000 commercial and test installations of the BES 10 system.  Given the company’s BES customer retention plan, EZ-Pass, it only makes sense for any BES customer to download, test, and install BES10.  EZ-Pass provides free upgrade to BES 12 if you have BES 10.   We expect that by the end of June, there will we be more than 50,000 BES 10 commercial and test installations. 

 From a value perspective there are several ways to appraise this business.  For example, how many customers will take your call?  We are guessing that most of the 80,000 logos will listen to a BlackBerry sales rep.  If you are Google, Apple, or Samsung, BES would deliver nearly instant credibility.  We guess this is worth at least $1,000 per enterprise or $4.0 to $5.0B. Add to this $1.0 to $2.0 value for the small business customers.   Call this $6.0B and divide by 3 to reflect poor current business conditions so we assign a $2.0B current value to BES. 

 Looking longer term, we see this business as worth several times our low estimate.  If the company can get $1,000 of annual revenue from each of 4,000 customers (assumes 50 managed devices per at current silver pricing of $20/device/year) and keeps BES express as free, we think 2X revenue is a reasonable, if not conservative value.  Of course, this reflects our belief that BlackBerry will successfully shift its model to charge for software.

Handsets $600/$1,000 MM

BlackBerry’s original device in 1999 was a pager with a keyboard.  Phones came next.  These devices consumed far less network resource than other early smartphones.  With a physical keyboard and relatively easy to read and control screen BlackBerry was an early success.  Many referred to the phones as Crack Berries as using them was so addictive.

In 2007 Apple raised the bar with the iPhone.  BlackBerry’s iPhone fighter, the Storm, did not come close.  Later Google raised the bar again with Android.  BlackBerry tried to fight Android with its new QNX based products.  These were late to market and lacked developer support to garner the broad application support of iOS and Android. 

Today the company’s handset business is in a tough spot.  There is too much legacy BlackBerry inventory in the hands of distributors making it hard for the company to sell its newer BlackBerry 10/QNX devices.  We estimate it will be the company’s third fiscal quarter before inventory levels balance.

Expect the company to deliver a new “Classic” phone later this year and an Indonesian market model dubbed Jakarta that electronics manufacturer Foxconn will build.  Foxconn has guaranteed BlackBerry that Jakarta will be a profitable product. 

The newer QNX phones – Z10, Q10, and Z3 are much more competitive than older Bold or BlackBerry 7 models.  The problem is that few appear to care.  In our recent unscientific survey of local carrier stores, not one had a salesperson aware that this generation of phones could download and run Android apps, or a practical 48 hour battery life. 

While we find the new phones largely improved, we do not expect them to unseat Android or Apple.  For now, we seem them as a reasonable alternative for customers wanting keyboards, greater security, longer battery life or smaller size. 

 Anecdotal Personal Experience with new handsets

 We have been using a Q10 for the last several weeks.  I agreed to try this as part of my research because I like keyboards, prefer Androids to iOS by a small margin and never really got the hang of old-school BlackBerrys.  Notably the device:

 Fits in pockets more comfortably than any other smartphone we’ve tested at any time.

• Is the same (light) weight of an iPhone 4S.
• Is very reliable.
• Is easy to use, and integrates well with other email and productivity suites.
• Downloads, installs and runs Android apps fairly easily.
• has a nice keyboard and excellent battery life (≥ 2 days)

 This has been a far better experience than expected. 

Handset Market and Valuation

 We do not expect BlackBerry to be wildly successful in handsets.   In the January quarter, we estimate consumers purchased about $710MM of devices.  That would imply an annual revenue business of $2.8B.  If we assume that the legacy business disappears the market shrinks to about half of that or about $1.4B annually.  Our low case valuation of $600MM is less than half of this.  Our high case assumes the company establishes itself as a “Security” niche handset maker.   To us this implies revenue shrinking to $1.0B annually, decent profitability, and a valuation of 1 times revenue. 

Patent Portfolio $575/$1,500MM

Right now, we see BlackBerry’s patent interests as under a cloud.  Currently, at the US Supreme Court is a significant software case, Alice Corp vs. CLS Bank.  In this matter, the Supreme Court will likely decide on the extent and validity of software patents.  We expect a ruling this summer.  The other valuation cloud we see, emanates from BlackBerry’s participation in the “Rockstar” group. 

 In 2011 Apple, Microsoft, BlackBerry, EMC, Ericsson, and Sony formed the “Rockstar” group to purchase Nortel’s 6,000 patent portfolio for $4.5B or roughly $750K per patent.  At the time, we thought this was a high price.  In hindsight, it looks like a very high price.  Moreover, intellectual property news boards and discussions broadly hint that Rockstar is willing to sell the portfolio and that BlackBerry is willing to sell its interest in Rockstar.  These two factors argue against a high price for these assets.

 We suspect that BlackBerry paid between $750 and $800MM to be part of Rockstar.  Our best read is that Rockstar has not been particularly successful in generating license fees for the portfolio.  The only sale we know of is a small patent suite to Spherix for $1.0MM plus a participation in future profits.  In October 2013, Rockstar filed suit against Google, Huawei, Asustek, ZTE, HTC, Samsung, LG, and Pantech.  Of these, only Huawei has settled.  This indicates to us that there may be a protracted court battle. 

 Because of these issues, we value BlackBerry’s Rockstar holdings at 50% of what it paid or about $385MM.  With positive clarification in Alice Corp. vs. CLS Bank, and another licensee or two, we would think a value $500MM may be reasonable. 

 The Globe and Mail newspaper has quoted Chipworks, the Ottowa based reverse engineering firm, as saying BlackBerry has about 4,200 issued patents with another 3,300 patents pending.   At $50,000 per patent, or something that approaches patent cost, this portfolio would be worth $375MM.  We suspect that, as a group, these patents are worth considerably more than $50K each.  For our near-term valuation, we assign a 50% markdown to the $375MM or $185MM.  This reflects the company’s weak financial position and weakened ability to defend its patents.  A healthier BlackBerry would be more able to defend its patents.  As a result, we think a longer-term value of $750 MM is attainable. 

 Lastly, in 2006, BlackBerry settled NTP’s lawsuit, paying $612.5MM for a complete license for it and its “affiliates.”  Today Vistio, Nokia, Good Technology, RIM, AT&T Inc., Verizon Wireless, Sprint Nextel Corp., T-Mobile USA, Apple Inc., HTC Corp., Motorola Mobility Holdings Inc. (now part of Google Inc.), Palm Inc. (now part of Hewlett-Packard Co.), LG Electronics, Samsung Electronics, Google Inc., Microsoft Corp., and Yahoo Inc. all have licenses.  The $250MM upside value we assign to this reflects the value to someone like Huawei or another entity without an NTP license. 

 Other Businesses

 We believe BlackBerry’s other businesses have the potential to attract customers, enhance the company’s competitive position and increase revenue.  Our scenario for a better services price rests on wider adoption of secure messaging.  In this instance, BlackBerry Messenger would also benefit.

 QNX appears to be the current market’s embedded OS of choice.  It is central to many connected car implementations and automotive systems in general.  We believe John Chen understands the challenges of monetizing open source or nearly open source software.  However, we expect Chen will focus efforts on BES, Handsets, and Messenger before investing heavily in this market. 

 Financial Liquidity

 While there are execution risks, we believe BlackBerry has more than enough cash to carry it to cash generation. 

 BlackBerry has $2,529 MM in Cash and Equivalents, and $1,627 in long-term debt. Roughly, $1,250 MM of this debt is 6.0% debentures that convert at $10.00 per share.  The debentures are not redeemable until Nov. 13, 2017.  Between Nov. 13, 2016 and 2017 the company may redeem the debentures are redeemable at 104% and declining by 1% in each successive year.  These debentures would add 125MM shares or 24% to the current 526MM shares outstanding.  

 Last quarter the company consumed $695MM in total cash, free cash flow was ($505).  Should this rate continue unabated, the company has sufficient liquidity to last roughly five more quarters.  We expect cost control and small revenue improvements somewhat offset by inventory build and marketing expense will modestly reduce cash consumption in each of the May, August, and November 2014 quarters.  During this time, we expect the company will receive about $220MM in real estate proceeds in the current (May) quarter and another $50 to $60 MM in its August or November quarters. 

 We think the fourth fiscal quarter (ending February 2015) will provide the first hint of normalization.  By then BES 12 should be shipping, BlackBerry Messenger will likely offer a more complete feature set, the new Classic phone should be in the market, all helping to stabilize the business.  The company is targeting break-even cash flow by the end of fiscal 2015. 

Catalyst

 Potential Catalysts 

• A handset related corporate security breach akin to compromise of credit card readers during the 2013 Christmas season. 
• BES 12: We expect the company will post adoptions, Beta shipments and other relevant information prior to the (currently) planned November general release. 
• “Jakarta” or Z3: We suspect few investors realize how much benefit BlackBerry accrues by putting Foxconn’s balance sheet at risk for this model.  As a result, we see this product’s progress as a catalyst.  On April 28 BlackBerry announced Indosat and XL customers could pre-order the device and the official unveiling would be May 13. 
• BlackBerry Hub/Messenger becomes available on Windows and Mac desktops. 
• Other handset and Mobile Device Management (MDM) makers appeal their failure to get Defense Department (DOD) Authorization to Operate (ATO) as BlackBerry has.
• The company gets a bid materially above our downside price but below our price target.