BlackBerry Shows Some Growth

BlackBerry BB reported better-than-expected results for its fiscal 2020 third quarter, with strength in nearly all product categories in software and services. The acquisition of Cylance along with the company’s revamping of its salesforce may be paying dividends, as BlackBerry posted sequential revenue growth across the board for the first time in the last three quarters. While such early indications of revenue growth improvement pushed the stock up after the earnings report, we continue to view BlackBerry as undervalued.

Revenue increased 18% year over year to $267 million in the quarter, mainly due to the Cylance acquisition and QNX gaining traction in additional markets. Excluding Cylance, BlackBerry’s total revenue was up 0.4% from last year, an improvement from the 1% and 0.5% declines in the first and second quarters, respectively. Revenue from Internet of Things enterprise software declined from last year but increased sequentially, which we view as encouraging. Given the company’s focus last quarter on improving its sales team via more internal training and possibly synergies across different products, we continue to expect the sales cycle to shorten and account wins to increase. Some wins during the quarter include Swiss bank Julius Baer, Canada’s Department of National Defence, and other federal agencies in Germany, Panama, Poland, Romania, Saudi Arabia, and the United States.

QNX won a couple of designs, with Hyundai focusing on its advanced driver assistance and autonomous vehicle platforms. Hyundai is more aggressively taking steps toward improving and commercializing its self-driving offerings by 2024, as reported in November by BusinessKorea. BlackBerry management says QNX is also gaining traction in other markets, including industrials. It plans to tap into the energy and medical markets as well.

Cylance revenue increased 13% from last year and 14% sequentially, driven by an increase in subscription clients and a 99% dollar-based retention rate. We expect continuing double-digit growth in Cylance revenue as the business begins to more effectively target not only enterprise clients with its endpoint detection and response offering but also small and medium businesses with its endpoint protection offering. We expect growth in Cylance to also drive growth in BlackBerry’s QNX and enterprise software as the company continues to integrate Cylance’s artificial intelligence cybersecurity capabilities into those offerings.

With more than 90% of its software revenue recurring, BlackBerry expanded gross margin during the quarter. Non-GAAP gross margin of 77% was up 90 basis points from last year. Operating income came in at $20 million, which represented a 7% margin, down 7 percentage points from last year mainly due to the company’s higher sales and marketing spending on Cylance and enterprise software. We expect non-GAAP operating margin to return to the 10%-15% range as top-line growth accelerates during the next 12-18 months and outpaces an increase in sales and marketing expenses. Last, BlackBerry guided to $1.1 billion total revenue for fiscal 2020, in line with our projection and S&P Capital IQ consensus. The company expects non-GAAP earning per share of $0.08, above our estimate and consensus.

Choosing Software Over Hardware We believe BlackBerry is well on its way to becoming an enterprise software company, but success remains to be seen. While the company has successfully left its hardware business, uncertainty regarding royalty revenue from the mobility solutions segment, along with the elimination of the high-margin service access fees, makes an investment in BlackBerry a risky one, in our view.

Through various acquisitions and the reallocation of resources toward faster-growing and higher-margin enterprise mobility management, or EMM, software, BlackBerry remains focused on expanding its enterprise software offerings and revenue. The acquisition of Good Technology in late 2015 showed BlackBerry’s seriousness in making its EMM offerings platform-agnostic, potentially attracting some of the growing number of enterprises that have adopted the bring-your-own-device model.

In addition, the acquisition of cybersecurity company Cylance in early 2019, shows BlackBerry’s continuing focus on providing enterprises with secure endpoint management technology. However, the acquisitions also demonstrate Blackberry’s ongoing difficulty in increasing its top line organically.

The company’s success on the enterprise software side has been masked by struggles in the smartphone hardware business. It took some time for BlackBerry to realize that attempts to revitalize its smartphone business will not generate any returns, as the company was slow to react to and compete effectively with the market-dominating Apple iOS and Google Android device operating systems. BlackBerry finally acted on this realization and washed its hands of the hardware business.

Still No Moat We do not see any economic moat factors creating or sustaining competitive advantages for BlackBerry. For this reason, we do not project long-term excess returns on capital, and we view it as a no-moat company.

BlackBerry is actively transitioning into a software and services enterprise. The company’s software and services segment consists mainly of enterprise software such as EMM, IoT, and software products including QNX, which has a market-leading position as the operating system used in a variety of automotive infotainment systems.

The $2 billion EMM market, which is projected to grow at more than a 25% compound annual rate, is becoming more of a necessity for all enterprises. With mobile devices no longer standardized across an enterprise (as BlackBerry’s smartphones used to be) as the bring-your-own-device model is becoming the norm, they still need to be integrated into the enterprise structure, which is where EMM products come in. EMM suites help with the enterprise deployment of cross-platform mobile devices, the tracking of those devices, and the protection of highly valuable enterprise data and other content that reside on and are shared via the devices. BlackBerry is the second-place player in this space (behind VMware’s AirWatch), as various acquisitions helped increase its market share to nearly 15% from 10%.

BlackBerry’s QNX IoT offering is currently the market leader, with slightly more than 50% share. However, as interoperability and clear communication between car infotainment systems and drivers’ mobile devices become more important, we believe QNX faces significant competition from much larger companies, such as Apple’s CarPlay and Alphabet’s Google Android Auto. QNX may remain the software system used in base models, but it could be rendered as middleware as customers layer CarPlay or Android Auto on top of QNX, or even move to systems that use CarPlay or Android without including QNX at all.