BlackBerry: Even The Bulls Are Giving Up On Hardware

Summary

• Recent bullish sentiment on BlackBerry acknowledges hardware weakness, but points to software and services as growth areas.
• Enterprise mobile device management is pointed to as an opportunity for BlackBerry.
• The ongoing collapse of the hardware business will probably force BlackBerry out of hardware some time in the coming year.

In anticipation of weak hardware sales for BlackBerry's upcoming fiscal Q4 report on Friday, the investment thesis of bulls has pivoted away from hardware. The focus is now on software and services, deemed to be areas of potential growth for BlackBerry (NASDAQ:BBRY). While possible, this outcome is unlikely, as enterprise embraces Apple's (NASDAQ:AAPL) iPhone, and the Apple/IBM (NYSE:IBM) partnership provides a more compelling mobile device management solution

Circling the Drain

A couple of bullish articles on BlackBerry have appeared recently on SA that basically say, "don't worry about hardware." Shock Exchangeacknowledged my observations about BlackBerry hardware sales, but argued that "network externalities" would stimulate BlackBerry's enterprise services business. Alex Cho was even more explicit in his exhortation to "ignore hardware" and focus on the company's software business.

Why do BlackBerry bulls want us to ignore hardware? Because the hardware picture is really dreadful. BlackBerry's phones are simply non-competitive. This is due in large part to the recycling of the commodity hardware paradigm by BlackBerry, which has become more and more untenable. BlackBerry phones use Qualcomm (NASDAQ:QCOM) processors, and not even particularly exceptional Qualcomm processors. Almost everything in the Android or iOS device worlds outclasses BlackBerry's best. This can be seen by going to the Geekbench website. In the chart below, I summarize Geekbench performance results for BlackBerry and some Samsung Android and Apple iOS devices (higher scores are better).

As a consequence, very few people are buying the phones. As of IDC's latest data on smartphone OS market share, BlackBerry had just a 0.4% market share in calendar 2014 Q4 and for the entire year of 2014. Market share is the percentage of new phone sales, and BlackBerry's rate of new sales is now no longer enough to support the BlackBerry OS ecosystem.

This can be seen in the continuing implosion of BlackBerry's hardware user base. As of the fiscal 2015 Q3 earnings report BlackBerry management acknowledge on page 3 of the Management Discussion section that the hardware user base has shrunk to 41 million. The chart below shows the contraction of user base and Services revenue since the baseline of fiscal 2014 Q1, when BlackBerry had a user base of 62 million and Service revenue of $794 million.

The hardware situation is unlikely to improve for fiscal 2015 Q4. The Kantar Worldpanel smartphone OS results indicate that BlackBerry's market share has continued to collapse in every major market throughout the world. Based on the Kantar data, I predict that sell through to end users will be about 2.2 million units, a y/y decline of about 35% from fiscal 2014 Q4.

Increasingly Speculative

In the face of the ecosystem collapse, the investment thesis on behalf of BlackBerry has become precariously speculative, involving predictions of where BlackBerry might be 10 years from now. I pride myself on a certain amount of foresight, but even I wouldn't venture that far into the future.

Bulls can point to the BlackBerry/Samsung (OTC:SSNLF) partnership and the Samsung-based SecuTABLET, but it's not clear how much revenue BlackBerry will derive from these. Mobile device management might be an inviting opportunity were it not for the hardware collapse. Yes, BES is cross-platform. So what. Here's the fundamental problem for BlackBerry.

As this report from Good Technology shows, enterprise is overwhelmingly choosing the iPhone. As the chart below shows, BlackBerry is in the 1% "Other" classification.

The report points out that iOS is particularly strong in "regulated" industries, with a 95% share of the legal industry, 82% share of the public sector and 81% of financial services.

The reason for this is that Apple has built an extremely secure smartphone operating system. Apple's encryption is so good that it wascriticized for being too good by the director of the FBI last year. Apple CEO Tim Cook went on to defend Apple at the White House security summit.

I often hear BlackBerry bulls extol the virtues of BlackBerry's security, and it's possible that it's even better than Apple's. But if the U.S. government can't break Apple's security, how much better does it need to be? The adoption of iOS by enterprise already provides the answer: BlackBerry's much-lauded security offers little added value.

If security doesn't provide an important discriminator relative to iOS, then that leaves mobile device management (MDM) as the last hope. But it's a false hope. The reason is the Apple/IBM partnership.

MDM has been a weak spot in iOS, and it hurt Apple in education last year. Apple realized that the adoption rate in enterprise was unsustainable without a better MDM solution, which is the reason for the IBM partnership. The IBM partnership provides enterprise-class MDM, as well as the support infrastructure that IT departments expect from IBM. The IBM partnership, combined with the high adoption rate of iOS devices, effectively slams the door in the face of BlackBerry's MDM aspirations.

What to Look for in the Earnings

BlackBerry typically doesn't highlight the user base number in its initial earnings release, so investors won't know that until the full report gets posted on line. Hardware sell-through will probably come in at around the 2.2 million units I'm predicting. The hardware story is almost a foregone conclusion.

What investors should look for is some sign of growth in the Software and Service segments. I don't expect any, however, because the growth premise is fundamentally flawed. I continue to regard BlackBerry as a short opportunity, although not for much longer. At some point in the fiscal first or second quarters, the hopes of the BlackBerry bulls will prove vain, and the price of the stock will collapse.

What will trigger the collapse? Chen has a decision to make, and he has to make it soon. Either BlackBerry gives up on hardware altogether, or it faces bankruptcy at some point in the coming fiscal year as it burns through its remaining cash. I'm betting that Chen will do the smart thing and get out of hardware. It's really the only way to save the company at this point.

But getting out of hardware will shake the faith of BlackBerry bulls to the core, and for good reason. BlackBerry without hardware is a muchsmaller company, and the cost of divesting the hardware business could be huge. That much smaller BlackBerry is not reflected in the company's current valuation.