Blackberry making a comeback?

I’ve written before about Blackberry (TSX: BB), but with a relatively large difference: I’ve been using a Q10 (the one with the keyboard) for a few months.

My mobile phone usage patters are relatively spartan, but I needed something with a keyboard on it. There was amazingly few options to choose from, so I picked up a Blackberry since it was the only thing available in Canada. I also do not feel compelled to be locked into a cell phone plan (which are all considerably more expensive than what I have presently, so would be functionally deferring the payment of the hardware device in the form of monthly cell plan payments), so I picked an unlocked phone for CAD$299 directly from Blackberry’s site. Surprisingly, the phone came a couple days after clicking on the purchase through FedEx. I also had concerns regarding second-hand phones (mainly that they were stolen and their IMEI would be blocked) and thus didn’t feel compelled to go down that route.

My previous phone could only be described as a very basic messaging phone that ran a proprietary Samsung operating system (not Android). It did the job until its touchscreen decided to slowly crap out. I have had little experience with the iPhone other than borrowing a friend’s on occasion. With Android (which is currently the world’s most popular mobile operating system), I do use it with a tablet, but only have used it with a phone on very rare occasion.

My quick no-BS review of the Blackberry Q10 is as follows: Once you get used to the user interface, it is a surprisingly good phone. It does a very good job of email and text management, especially how it consolidates multiple email accounts. Battery life is very lengthy, to the point that one generally doesn’t think about it. The browser is fine (although not a replica of what you would see on the tablet), but the relatively large drawback is the smaller screen (which is the tradeoff of having a keyboard). When turning off data, the Wi-fi function works seamlessly well with the rest of the phone. It is an incredibly functional device and a very large step up from what I previously had.

I generally do not use many other external applications. This is probably why I don’t mind the phone, while others seem to have a need to access the millions of pieces of junk software out there that are available to download (Candy Crush, etc, etc.) on Android. Curiously, the one Android application that I found is a “killer app” (which is an offline mapping application) works perfectly on Blackberry. It was shockingly seamless to get onto the phone and operate.

I will now discuss the investment analysis of Blackberry. Despite the fact that they are going to launch another (larger) phone with a keyboard, it will not materially matter for the company. The mobile phone market has well progressed beyond the stage where hardware no longer matters, and everything is about software.

The analogy is very similar to when personal computers (PCs) were hitting the mass market, and the bulk of the profit margins were not made with the hardware makers (Hewlett Packard, Compaq, Gateway and Dell), but rather the software makers (Microsoft functionally winning the winner-take-all market of operating system and office suite, while the rest were left with the scraps).

The mobile phone market has considerable differences to the PC analogy.

One is that it doesn’t matter what software the phone is running, they will all connect to the cellular network. All the major operating systems have basic functionality (email processing, text messaging, phone calls, contact list management, web browsing) that all perform roughly equivalent to each other. Other than consumer taste (or in the case of Apple, an element of positional good), there is little difference between the choices in terms of functionality. The big difference between the three is the ancillary services that they are able to offer. iPhone offers the Apple ecosystem. Android offers the Google ecosystem. Blackberry offers no real ecosystem, but allows access to the Android market.

Unlike Microsoft Windows during the days when operating systems mattered (if you didn’t run it, you couldn’t access anything that made your computer productive unless if you were into Unix), mobile operating systems matter a lot less and thus their relative market power is reduced. The application market (and choice) is a somewhat relevant consideration on the mobile end, but much less so than 20 years ago when Microsoft Office was the killer product. Today, there would be a “killer product” if only one offering had a functional web browser and had a huge patent moat to prevent others from getting it, but clearly that is not the case.

Apple and Google are going to have to figure out how to prevent mobile carriers from extracting most of the economic value out of the market, but this is another topic for another day.

The point of this post is that Blackberry could come out with the best hardware phone on the planet, and it will not make much difference on their profit margin because mobile phone hardware has more or less become commoditized like PCs were about 15 years ago. Instead, the money is to be made on the software end and the sale of ancillary services.

In Blackberry’s case, this comes in the form of providing business-level integration with corporate information systems. I am not sure how they are going to make this as profitable as it once was, but there is likely a market to be made considering that Android and iPhone were not designed with corporate concerns in mind (e.g. security is often-cited, although it remains to be seen how Blackberry can restore its reputation after giving its keys away to the government of India a few years ago). Another platform which they clearly have an advantage with is the issuance and tracking management of corporate-owned mobile devices.

The QNX operating system unit does have potential with embedded systems (e.g. automobiles and other devices), but this is mostly under the radar.

Finally, BBM is often cited as having value, and in an era where Snapchat and Whatsapp can fetch billion-dollar valuations, there would surely be some market value ascribed to an instant messaging network (although if you ask me, there is far less than what the market valuations would suggest).

So in terms of raw valuation, while Blackberry is going to launch a major new product this month, I very much doubt that it will lead to bottom line improvement. This would come elsewhere in the company’s pipeline. I suspect the new CEO, John Chen, realizes this, but also knows that public perception is an integral part of restoring Blackberry’s credibility, and this includes having good hardware to support the software that will be generating the actual profits.

So at CAD$11.80 or a $6.2 billion market cap, is this a buy or a sell? Too tough to say at present. I was thinking about it earlier this year at CAD$8 (which my gut-feeling suggests is a low, but not ridiculously low valuation for the technology pieces), but did not pull the trigger.

Preparing for a year 2000-type scenario

I am relatively convinced that although the economy appears to be muddling along with a low real growth rate, the markets are pricing in a growth trajectory that is optimistic. We are likely to see increased volatility in the future.

There are some good doomsday type stocks, but perhaps none would be better than Fairfax Financial (TSX: FFH), who have continually prepared for a gloomier future. They have hedged their entire equity portfolio against the S&P 500 and also have purchased CPI-linked derivatives that would profit in the event of a deflation. From Prem Watsa’s annual report, he believes that any credit event in China would cause commodities to collapse (they consume 40-50% of most commodities from iron ore to copper) and it would have an impact on the mining industry. He goes on to state that world iron ore capacity has increased by more than 100% in the last ten years, mainly due to increased Chinese demand.

The excesses in the Chinese real estate market are quite well known and have been reported extensively in the past, but just like what happened in the USA from 2004-2008, it might take some time before any credit events emerge. In addition, the Chinese government has proven to be very adept at managing the situation.

While I don’t profess to if or when such a credit event will happen, if it does occur, it would be very adverse for Canadian investors holding equity and debt in such entities. Fairfax is an interesting bet for a doomsday scenario, but at CAD$470/share they are considerably priced above book value (which is US$339 at the end of 2013 or about CAD$374 at current currency rates). Given the performance of Fairfax’s businesses, one would expect a modest premium over book, but 25% over book seems a bit heavy to swallow. The company also sold 1 million shares at CAD$431 (CAD$417 after expenses) in November, but this was also in relation to their purchase of Blackberry convertible debentures.

Bone-headed valuations marking the end of the cycle

The big headline is the deal Facebook made to acquire WhatsApp for an absurdly large piece of change – $4 billion cash and $12 billion in stock. There was also $3 billion in extra restricted stock that vests over four years, but really, $3 billion is a rounding error.

The owners of WhatsApp should be given a massively huge congratulations for extracting a huge pound of flesh and hopefully they will have the foresight to start hedging their stock so they’ll be able to live in luxury forever.

I highly suspect in five years or so that the guys at Snapchat and Instagram are going to be kicking themselves for not dumping their businesses at equally absurd valuations. They’ll probably end up being like Friendster when they are superseded by some other up-and-coming application service.

I am not a user of either technology, either Facebook or WhatsApp (or Snapchat and Instagram for that matter!). Today was the first time I ever heard of WhatsApp, and just looking at the Wikipedia summary, it looks like a well-used and functional version of BBM crossed with Skype.

This also explains why Blackberry is up today – if WhatsApp can fetch $16 billion, why can’t BBM?

Media is already panning the deal and I seriously have no idea whether this makes any sense for Facebook strategically – eventually they will want to fold the WhatsApp’s not insubstantial user base into Facebook in some seamless transition, but one can just ask Google how things went with Google+ and you’ll easily see it is a lot easier to do that on paper than it is in practice.

Financially, of course $16 billion is a huge price to pay. Even if you assume the stock component of the deal is worth zero, the $4 billion in cash is a huge investment. Putting that $16 billion in a 30-year treasury bond will reliably spin off $600 million a year in pre-tax income for 30 years and does anybody seriously think that WhatsApp will contribute that incremental income to Facebook’s bottom line?

This acquisition reminds me of what happened when Yahoo acquired Broadcast.com (from Mark Cuban), or the mergers that occurred in the optical networking space in the last couple years of the dot-com boom where you had massive equity-for-equity transactions (in particular, JDS, Uniphase, and SDLI come to mind).

Acquisitions like these highly suggest the 20-times-sales valuation hype is going to end sooner than later. I don’t know when, but I’m staying far, far away from this territory and letting the insiders and lucky day trader-types make their killing to the detriment of those that will be holding the bag when the party ends.

Former Blackberry CEO dumps stake

Michael Lazaridis sold enough shares to have a 4.99% ownership stake in Blackberry. Below 5% he is no longer required to file with the SEC if he wishes to dispose of any more equity.

The material part of his SEC filing is:

(c) On December 23, 2013, 1258701 sold 3,166,893 Shares at an average price per share of $7.55 and on December 24, 2013, 1258701 sold 333,107 Shares at an average price per share of $7.63, in each case through open market sales.

What a vote of confidence. He raised $26.45 million out of these transactions, which would have been a quarter billion had he done this three years ago!

Blackberry Q3-2014

It looks like sentiment reached its maximum in mid-December; also just after the earnings release the lowest trade after-hours was at $5.70/share. Clearly the market over-discounted the negative aspect of this quarterly result despite the fact the company’s revenues were well below consensus.

It still remains an interesting business case, whether their existing businesses are viable after shutting down their consumer end. I think their QNX segment has value, but how much is another question. I generally believe their BBM technology is over-hyped and is going to become a “me-too” type product even when ported to other consumer platforms (Android and iOS). It reminds me of what happened to OS/2 when they successfully were able to have Windows 3.1 applications run within the OS/2 operating system – why bother when you can just have Windows 3.1 and not have to mess around other operating systems?

Anyhow, no positions and I will not be taking one. Too many eyeballs are on Blackberry and a lot of those eyeballs are connected to brains a lot smarter than I am.

Timing Blackberry

Blackberry is going to be an interesting business case as they are clearly not going down without a fight.

They are going to report quarterly results on December 20, 2013. I would expect these results to be very sub-optimal simply because if there was some signs of revenue stabilization it is much more likely that they would have found partners in the proposed buyout at US$9/share. Since there were multiple parties out there that were looking at the internals of Blackberry during October and would have received full visibility in two of three months of the fiscal cycle, I very much believe that revenues will be well below the $1.58 billion consensus estimate that I see on Yahoo at the moment.

In addition, with the new CEO cleaning house at the upper management level, it is going to take at least three to six months for them to realign the company and apply resources to the appropriate strategic priorities the company needs to focus on to get back to a profitable setting. However, the fact that he is cleaning house is a positive signal even though you will not be seeing the results of such actions for at least half a year.

That said, with the expectations in the stock market, I would expect rock bottom to be hit at the end of the year. Not only will they likely produce a lower-than-low expectations quarter, but you will also have the avalanche of tax loss selling and portfolio window dressing – which portfolio manager out there except for Prem Watsa would want to see this dog in their portfolio at year-end?

The sentiment regarding this upcoming quarter is quite bad. The question is how much the market has already baked in an upcoming bad quarter. Have they over-discounted?

DISCLOSURE: A friend of mine who I consider to be quite tech savvy, who already owns a Samsung smartphone with one of those giant screens, recently bought a Blackberry Q10. He suffers from a “can’t type on a touchscreen if it could save my life” syndrome. I share the same syndrome and am actually in the market looking for a usable phone with an actual physical keyboard. Other than that, no positions.

Fairfax Chart and Blackberry

Normally when a corporation is buying out another entity (especially at a premium), the market’s instinctive reaction is to jettison the shares of the purchaser.

Fairfax’s slow attempt to take Blackberry out has a rather odd effect: Fairfax’s common share price has skyrocketed (at least relative to its historical trading patterns, which has been relatively boring):

ffh

There is a deep insider’s game being played with Blackberry and some of this information leaks into Fairfax’s stock price. Maybe I’m reading too much into this (realizing that Fairfax’s 10% stake in Blackberry is only about 5% of Fairfax’s market cap).

My hunch:

1. The terms of the deal were materially struck on October 25th and will likely be announced on November 4th in absence of any other deals;
2. Facebook getting into the scene is priced in as a negative (i.e. potential to pay more, hence worse for Fairfax).
3. The market believes Fairfax is getting a good deal.

Zuckerberg at Facebook is not an idiot and realizes that his $120 billion market cap is not going to last forever and the company needs to branch out. Similar to what Steve Case did with AOL and Time Warner, there is an interesting business case of just sheer diversification of doing an all-stock deal for Blackberry at some double-digit per share price – Facebook stock is now expensive currency and why not do a late 1990’s internet stock type move and purchase something tangible?

Its a low probability outcome, but right now capital is cheap and the market is giving the titans lots of currency to play with.

Blackberry – Mother of all revenue misses

Blackberry pre-announced their quarter today, announcing that their revenue estimates are going to be about half of what analysts were expecting.

Their stock, surprisingly, was only down about 17% in the half hour that traders had to disseminate the information before the market closed. Quite frankly, given that their mass-market handset sales have plummeted to very little, I am surprised that they aren’t trading down further. Part of the reason why they haven’t dropped further is that there is implied value the company can fetch in some sort of liquidation.

Balance sheet-wise, they are still in a relative position of strength – with a couple billion in cash in the bank and no long-term debt. They’re probably going to have to utilize this for severance packages as they are laying off half their workforce.

Strategically speaking, Blackberry is now shifting to its roots in the business end – presumably getting out of the consumer market. It will be interesting to see whether there will be much of a market left for the technology side within organizations.

That said, if the stock gets hammered further, I will be eyeing some for a purchase. It is still slightly away from a point where I will consider a purchase and I would also need to see the actual quarterly results themselves (which will paint a bunch of doom and gloom). There will also be the component of people that will be dumping their stock by the end of the year to book a tax loss, and who wants to have the embarrassment of actually owning Blackberry any time this year? Anybody entering into the stock in 2013 will likely be guaranteed to be sitting on a loss.

On a total side note, if they are writing off their existing inventories of Z10s and other mobile units, I am actually in the market to just do a straight purchase without committing to any length of period for a mobile service contract. Maybe if they are going to do a fire-sale of inventory that I’ll finally pick up a new phone compared to the nearly-broken dinosaur I currently have for a mobile phone. Right now I clearly am not interested in paying $625 for one of them, but if they slash prices by half, I can easily upgrade. I did have a chance to try out the product and they are well designed, despite all of the negative mind-share that Blackberry has today.

Disclosure: No positions.

Blackberry, Nokia and Microsoft

Microsoft and Nokia announced a deal today where Nokia would functionally sell its mobile phone division to Microsoft and license the related intellectual property for a total cost of about 5 billion Euro.

The implications for Blackberry is that one potential strategic suitor (Microsoft) is probably gone. Just from a systems integration perspective it would take forever to fuse together technology from Nokia and Blackberry to make any sort of merge feasible.

The other data point is that 5 billion Euro gives a valuation benchmark for equivalent technology. Although the analogy is very loose, it does give some benchmark for Blackberry’s valuation – also noting that Nokia’s revenues that are being sold away consisted of about 15 billion Euro a year.

All in all, I am somewhat surprised that Blackberry is trading higher today.

Blackberry and short sellers

The 145 million shares of Blackberry that were short sold are being rapidly covered over the past few trading days. The worst news they could have is that the company is interested in going private or being bought out, and this is primarily the reason why the stock is experiencing the price spike.

This is a little depressing for people that were looking to go long and have no position as this completely takes the company out of the radar now. When you’ve dumped many hours of research into something and see it go to waste like there, there is a little resentment, but now the research radar will get taken to other directions.