BlackBerry (NASDAQ:BBRY) seems to have redefined itself as a software security company yet its valuation has become frothy
Thomas Chapman | June 15, 2017 | SmallCapPower: In FY 2017, BlackBerry Limited (TSX:BB) (NASDAQ:BBRY) seemingly redefined itself, as the Company changed its strategy to focus its business on software and services that secure, manage, and connect the enterprise of things. This begins a new chapter in the history of BlackBerry. The Company we all knew best for its QWERTY keyboard smartphone that dominated the early 2000s has stopped producing hardware as it aims to become a leading software and services company. We believe BlackBerry as a software company will succeed due to the following reasons:
- Moving to a software licensing model has improved significantly the Company’s financial health
- BlackBerry has a brand reputation of being a top tier software security company
- BlackBerry QNX provides significant upside potential
BlackBerry’s revenue declined 40% to 1.3B in 2017. It is important to note the decreased revenue came from two of their three business segments, the Mobility Solution and SAF segments, which both relate to revenues generated from either the sales of, or fees from, physical handheld devices. The decrease in revenue was due to an aging product portfolio of handheld devices as well as a lower number of BB7 users. These business segments are both profitable so it is likely the Company will continue to milk them down to the last dollar. When that happens, BlackBerry will become a pure software and services company. Software and services revenue increased 23% to $562mm in 2017, due to the acquisitions of Good Technology and AtHoc Inc in Q3/2016. Furthermore, this segment made up 48% of revenue with gross margins of 80%. As this business segment grows, expect margin expansion due to the higher profitability of the segment.
BlackBerry segmented revenue
Source: Company filings
The Company currently has $26mm in inventory, when it sells this off it should free up working capital and improve cash flows as they will have no more inventory to finance. BlackBerry has a great balance sheet, with virtually no debt and ~1.5B in cash (due to an $815mm arbitration win), and generated free cash flow of $16mm in Q4/2017. The Company intends to put hundreds of millions of this cash towards R&D.
BlackBerry QNX
There is a lot of hype surrounding the BlackBerry QNX infotainment system, as their software is installed in 60mm cars by some of the top automakers in the world. Some people in the investment community think this alone is enough to justify a high valuation, with beliefs that a company like Google would be willing to pay top dollar for that user base. We don’t think this it is sound investing practise, however, to buy a company on a speculative thesis like that. We don’t think BlackBerry’s QNX software for infotainment systems will propel their revenue growth, due to their recent loss of GM and Toyota as customers, and the highly-competitive market filled with players such as Linux and Google.
We believe BlackBerry’s growth will come from security software because that is where they have an advantage. BlackBerry’s smartphones sold because they were the most secure smartphone on the market. Although the demand for the Company’s smartphones has decreased, the demand for software security has gone in the opposite direction. BlackBerry QNX is currently developing an anti-car hacking software that will be available in 2018. The software is being developed in conjunction with Jaguar Land-Rover and is expected to make $10 per vehicle per month.
With all the hype around QNX, many investors have seemingly forgot about the rest of BlackBerry’s software security portfolio. In 2016, BlackBerry added four software security companies to its portfolio, two of these acquisitions alone added an incremental $129mm in revenue, which is just $21mm less than what they make per year on QXN. BlackBerry estimates the software security market to grow at 10-15% in 2018, and given the Company’s brand and security expertise we believe they will grow to the higher end of this range.
Valuation
Even when looking at BlackBerry as an exciting, new tech company, it is hard to justify their current $5.7B valuation. Management expects BlackBerry’s software and services segment to grow at the high end of the 10-15% rage in 2018, giving them revenues for the segment of $646mm when applying the 15% growth rate. Then, assuming revenues from their other business segments will decline at the same pace they did in 2017, we get total 2018 revenues of $1.1B. Applying the North American Software & Services industry median EV/Revenue multiple of 3.13x and applying it to BlackBerry’s 2018 revenues gives us a valuation of $5.16B.
BlackBerry Valuation
Source: Ubika Research
BlackBerry is a company that has begun a new chapter as a software security firm. They are essentially a start-up tech company that generates free cash flow, has a great balance sheet, which includes $1.7B in cash, has an established brand, and has great growth prospects that could yield big results if it plays out well. The valuation, however, does not seem to be in line so it may be best to wait a couple years to see how big of an impact BlackBerry QNX has on the market.
Disclosure: Neither the author nor any of the principals at Small Cap Power, or their family members, own shares in any of the companies mentioned above.
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