BlackBerry or BlackBeary?
Yesterday I mentioned the fairly bullish report from Scotia Capital, talking about upside in Research In Motion shares based on a successful BlackBerry 10 launch.
I've gone on a bit of a data-gathering rampage since last night. So between tons of reading and thinking, and plenty of coffee this morning, I have a much clearer picture of how analysts are thinking (and financially modeling) the next few quarters.
The big upside scenario is based on BlackBerry 10 device shipment volume and rebuilding of channel inventory. Gus at Scotia Capital outlined that scenario nicely.
So does everyone feel the same way? No. And that's what makes a market. You have buyers and you have sellers. At the risk of angering the few folks who do not understand this concept, let's look at the bear case as outlined by two analysts yesterday. I'm pulling the quotes from these reports (shown below) from Barrons. I do not have the full reports from these analysts so I'll restrict my commentary to the portions of the reports posted here.
Here's what Morgan Stanley published, followed by my thoughts:
We continue to believe BB10 has a low chance of success. While some of the new features on BB10 seem innovative, we had a similar reaction to Palm's WebOS when we saw it at CES in ‘09. Ultimately we believe BB10 is too late, and subs continue to shift to competitive devices. According to a global mobile workforce survey in mid-Oct, just 5% of respondents expect to upgrade to a BB, even below MSFT at 8%.
We continue to believe FQ2'13's relatively healthy results were a temp respite driven by a mix-shift to BB7 and growth in lower-end subs. With the competitive environ only tougher, fundamentals should deteriorate.
We expect services rev to begin declining in the Nov qtr accelerating thereafter as BB10 does not use RIM's NOC in the same way prior versions did, reducing service ARPU. We believe services biz is RIM's most important asset, and value services at $12/sh in a near-term wind-down scenario but $0/sh in our $7 SOP PT, as it supports the loss-making devices business.
Our developer checks continue to indicate limited interest in supporting BlackBerry. An IDC survey found that just 9% of developers were "very interested" in BB apps in Aug ‘12, down from 40% in Jan '11, after surveying 5,526 enterprise app developers globally.
My thoughts: Comparing RIM to WebOS is an overused and insane activity. Palm ran out of cash. Period. They did not have the funding to do a real launch. Without a marketing engine you have almost no chance of success. So this argument doesn't hold water in my opinion.
Notice his comments on service revenues? He's saying they'll start to decline (which worries me too), but his reason for saying this differs from mine. I don't think it has anything to do with how the NOC is used in BB10 versus BB7. The NOC is still used, and the only real change is the use of Activesync to push email and PIM data. Everything else is still proprietary to RIM. The NOC fees (aka service revenue) have everything to do with how carriers see its value today compared to when they originally signed deals with RIM. It has nothing to do with how BB10 uses the NOC "differently".
Boiling it all down, Moran Stanley is saying BB10 won't catch on, and service fees will drop. Those are definitely risks, but I do not agree with most of his reasoning.
Now let's take a look at Macquarie's comments:
Our carrier checks indicate that North American carriers are each likely to take one or 2 BB10 devices and that the company is likely to benefit from channel fill in the February and possibly May qtrs. Given low levels of RIMM channel inventory, the company could post upside to our above-consensus 8.0mm smartphone units in the Feb. qtr. As a reminder, RIM sold 11.1mm units in the Feb. 2012 qtr. with a stale product.
Our current break-even EPS forecast for Feb. qtr. assumes 8.0mm units, $233 ASP and 33% gross margin. Each additional 1.0mm units would result in $.11 per qtr in EPS, each $10 increase in ASP would create $.02 and each 1% improvement in gross margin would be $.04. Our blue sky scenario, assuming 36% gross margin, 9.5mm units and $250 ASP, would be $.39 in qtrly. EPS.
Even if BB10 is successful and annual earnings recover to the ~$2.00 level, we wouldn't expect RIMM to trade up to more than $16-$20 or 8-10x PE. If BB10 does not sell well, RIMM stock could easily revisit its $6 lows, so risk/reward is now balanced, in our view.
My thoughts: What's he saying? He believes carriers will support BB10. Ok, that's good. He believes we'll see channel fill in the first couple of quarters. That's also good. He points out that his own forecast (above consensus) may be too low since RIM did pretty well last Feb on stale hardware. All true.
He then explains his sensitivity analysis, illustrating that device volume, ASP (average selling price) and hardware gross margin are the biggest controlling variables in the profit equation. I agree. Keep in mind his gross margin numbers are overall (hardware + software + services). Those are not hardware-only estimates.
The bearish part of the discussion is really at the end. He's saying that even if RIM succeeds, earnings go to $2.00 per share. So in his opinion, the price of the stock today reflects a fair balance of upside to $16-20 and downside of $6.
Like I said, I haven't seen the entire report. I don't know what else he wrote. But you can see from these two analyst reports that the focus on hardware shipments, ASP and gross margin is what the Street cares about now. That's the primary concern. Beyond that, everyone wants to know the dynamics on service revenue
The BlackBerry 10 Financial Model
From most of the reports I've looked at, analysts seem to expect an ASP of $400ish on the new BlackBerry 10 hardware coming out in Q1. Gross margin estimates range from 20-30%, which tells us that the estimated manufacturing cost (all in) will be $280 to $320.
If we look at BlackBerry 7, my rough math suggests current all-in manufacturing costs are about $250. This jives with the fact that ASP is just under $230, and we know RIM is losing money on hardware today.
So what does it cost to build a BlackBerry 10 devices over and above a BlackBerry 7 device? Considering the higher screen quality, faster processors, better cameras, and the addition of LTE I think a cost bump of $50 seems reasonable.
This leaves us with ASP. Can RIM sell these suckers for over $400? Apple commands over $600 for an iPhone 5, so that defines the high end. Nobody else gets there aside from Apple. Who can tell me what carriers pay for Samsung Galaxy S3, or other high end Android phones? I'm not talking about subsidized prices or non-contract retail prices. I'm talking about what Samsung is paid by the carrier. Is it well above $400? If so, why shouldn't RIM be able to price its awesome new phones at the same level?