Last Friday we had a chance to look at the Q4 financials for BlackBerry, and the CrackBerry team held a podcast to talk about it. Were we all doom and gloom? I don’t think it was quite that negative, but we are keeping it balanced and considering the good and bad areas of the business when we talk. No sugar coating.
Over the weekend I did some more thinking about BlackBerry, while enjoying the fact that spring FINALLY arrived in Toronto. I also had a chance to read a well-written report from GMP analyst Deepak Kaushal. While it was quite bearish, I believe the analysis adequately looks at the business. In other words, Kaushal isn’t trying to paint a negative picture on purpose, and he clearly lays out what he believes needs to happen for BlackBerry to hit its goals of being cash flow break even by the end of this year.
One of the things most good analysts do in their forecasts is estimate gross margin for the hardware and software business on a quarterly basis. The company actually discloses it annually, so when this disclosure is given at the end of each year you’ve got to go re-calibrate your model to make the numbers fit in order to reasonably estimate the quarterly numbers. Kaushal estimates that BlackBerry had -19% gross margin in the hardware business last quarter, an improvement from -35% in prior quarter.
My thinking: It’s scary to see hardware margins so firmly in the negative, but it’s great to see the big quarter over quarter change. It really helps me get my head around the possibility of zero to slightly positive margins in the hardware business sometime this year. If Kaushal’s Q4 estimates are right and we assume BlackBerry gets hardware margin to 0% while keeping hardware revenue flat then it implies about a $70M increase in gross profit. That would go a long way towards putting the company closer to cash flow break even.
It’s scary to see hardware margins so firmly in the negative, but it’s great to see the big quarter over quarter change
But as Kaushal correctly points out, the service business is the big mover right now. This service revenue is probably a mix of 20% enterprise customers and 80% BIS customers, and brought in $546 million in the last quarter, with margins in the low 80% range according to Kaushal’s estimates. This revenue has been eroding at about 13% per quarter, so if this happens again in Q1 it will shrink the gross profit by almost $60 million in a single quarter.
Think about it. If BlackBerry can get hardware margins to zero the upside from this will be lost, almost entirely, with a single quarter of service revenue declines that stem from a reduction in BB7 subscribers.
So if BlackBerry is to actually get the company to cash flow neutral by the end of this year it needs to hold service revenue flat, keeping margins flat, while also bringing the hardware business to zero margin (from negative today).
Can they do it? I think on hardware they probably can. The huge improvement in Q4 gives me some confidence in that regard. But on the service front I don’t see how they’ll stem the revenue decline unless BB7 demand remains very robust all year long. Remember that we have low cost BB10 phones coming - something I think is the right move.
Also remember that BlackBerry probably doesn’t have any material new revenue streams to turn on in the services side of the business until BES12 is released later this year. This leads me to believe that BlackBerry’s cash flow break even forecast heavily relies on the last quarter of the year, where they expect to sell a lot of BES licenses. Also, it’s possible that hardware margins could continue to turn upwards, leaving them with a profitable hardware business in the current fiscal year.
All in all, the company is in a tough spot. The rest of calendar 2014 is not going to be pretty on the financial statements. But I think there’s a good chance they are capitalized well enough to take them through the transition if they execute well.
The story is definitely still interesting, that’s for sure.
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