BlackBerry: Ignore Hardware, It's Time To Focus On Software

Summary

• Investors have underestimated the upside in BlackBerry Enterprise Services.
• I estimate that its software business could scale into a $5B per year business by FY 2025.
• When operating at a 30% profit margin, that's a net profit of $1.5B.
• The numbers seem reasonable as the mobile handset market and the need for device management will grow in-line with the figures that I mentioned above.
• However, it's difficult to anticipate BlackBerry's market position, hence I model a scenario in which BlackBerry has 25% penetration, which seems reasonable in light of competent competitors.

Developing an edge in the markets takes a while, and while various strategies propose concrete ideas on what will likely drive business, I often find many fall short of the promised land, either because they're way too valuation focused or lack a concise idea on what will likely be an earnings catalyst going forward.

In the case of BlackBerry (NASDAQ:BBRY), I'm fairly confident that the growth catalyst will be software first, hardware second. None of the product offerings (Passport, Secutab, Bold) really excite me, nor did they generate the initial jump in sales that I was hoping for.

But…

The security service, i.e. BlackBerry Enterprise Services, is something that I find immediately relevant in a commercial setting as controlling information flow and ensuring containerization will limit the way data is manipulated and shared on devices. Also, financial services, technology and biotechnology do demand the protection of trade secrets, patents, and sensitive information, which will require more complex security software suites, as not all devices have finger print or retina scanners. Furthermore various anti-virus suites aren't a comprehensive enough of a solution as they are not a foolproof safeguard against employee data theft.

Despite the practicality of the software solution, the actual revenue is a "trickle" in comparison to other business units, and while I would argue that this could be the most valuable business ten years from now, it's currently early in its infancy, indicating that the valuation associated with it wouldn't be very meaningful as investors aren't going to price a premium on smaller yet promising business divisions.

Also, it's unlikely that investors are going to chase the stock on BES alone as we would need to see some stabilization in both hardware and services.

Software is small, and when I mean small, it's only representative of 6.8% of total revenue. Not exactly a precursor to gangbuster growth, right?

(click to enlarge)Source: BlackBerry

That's where John Chen interjects with a bit of dry humor on the current state of the business and its potential growth rate:

So I think, first of all, yes, I'm still on the path of doubling our software revenue the next year. So just to make sure we have gone through the numbers correctly, today we talked to you about $250 million. That's inclusive of licensing, license and technical support.

So if FY 2015 is roughly $250 million - $300 million (I'm offering a bit of a stretch in terms of the range of outcomes), the business is too small to make any meaningful dent into the company's earnings.

However further data indicates that there are bigger legs to growth going forward, which is where my excitement for this business comes from.

Supplemental data indicates that the MDM (mobile device management market) could grow at a much quicker rate. For example, a Forbes article mentions:

According to Radicati Group, a market research firm, the mobile device management market is expected to more than quadruple to $5.75 billion by 2018. Although BlackBerry is the current leader in the MDM space, with about 14.4% market share according to IDC, it is losing share to rivals such as MobileIron.

Admittedly, the lack of market share is a little alarming, but with such a large sales force, proven branding and competitive pricing, I'm willing to anticipate that BlackBerry can capture 25% market share when taking into consideration that it prices its silver license at $19 per user per year and gold at $60 per user per year. This indicated that if the projection is seemingly accurate, BlackBerry could scale software into a $1.437 billion business, which sounds a little far-fetched, maybe overly optimistic, but when dealing with early stage growth businesses, perhaps it's OK to anticipate bigger numbers.

That being the case, growing from $300 million in FY 2015 to $1.437 billion in FY 2018 implies a 68.57% CAGR. That being the case, if we assume that from 2018 onward the business scales from $1.437 billion at a 20% CAGR until 2025, we're looking at a $5.14 billion business.

The long-run growth assumption is based on broad-growth in cloud services in general and is intended to be a conservative measure following the initial stages of growth. IDC projects that SaaS will grow at a 21.3% CAGR over the foreseeable five-year period. So I model long-run growth on SaaS, as it's inclusive of more mature software business models, along with more recent ones.

Hmm… not bad, but is it actually attainable?

Well, let's assume the average license per year is $40 (roughly even split between silver and gold) that would imply 128.5 million licenses.

Whoa! That sounds crazy right?

Not really… as over a billion devices ship per year, and when we look at Qualcomm's (NASDAQ:QCOM) forecasts for device shipments, it's not that far-fetched of a reality.

(click to enlarge)

Source: Qualcomm

When working with Qualcomm's figures, there will be 3.6 billion handsets (running on two-year refresh in CY 2018) and if BlackBerry can penetrate into approximately 3.56% of the installed base of all devices (which is again an attainable figure).

Admittedly, I don't have an exact break-out on enterprise devices because enterprise devices are being replaced with a BYOD concept, i.e. bring-your-own device.

According to statistics from the International Labor Organization, the service sector is projected to employ 1.477 billion people by the end of CY 2015. I excluded data from the industrial sector, because it's not exactly clear whether industrials will find MDM software that useful as their CAPEX and OPEX leans towards capital goods (mechanical and less electrical components) and commodities.

So from my research, the potential market globally is approximately 1.477 billion devices, and selling 128.5 million licenses for BES 12, would result in a $5B+ a year business. At a 30% net profit margin, that would equate into $1.5 billion net income. A reasonable time frame for accomplishing this is around 2025, but it's not impossible for BlackBerry to grow sales at a higher rate than this.

Admittedly, my forecast is a little aggressive, but when it comes to software, it may pay off to wait for the tide to pass in a deeper part of the pool. Sure it's a little uncomfortable initially, but I think that there's a decent chance that investors are missing the true value of BlackBerry, which is in its software, not hardware.

There are emerging competitors, like Microsoft (NASDAQ:MSFT), which is set to release mobile device management software into the Office 365 suite. Admittedly, the functionality is somewhat limited, and quite frankly it's Microsoft's attempt at offering features to sustain growth in its office productivity business as a result of OS-license sales being negatively affected due to competing ecosystems that don't charge OS-license fees.

I would consider Microsoft a legitimate competitive threat because their software development teams have extensive experience in dealing with data security as an extension of their capabilities in the cloud via the Azure IaaS platform. There's also IBM with its own MDM offering (mobile as a service 360), but I question whether it will be truly effective as IBM doesn't actually operate a mobile handset division and is currently struggling with maintaining its software licensing business. There are a couple other noteworthy competitors that can emerge as big winners, but that doesn't negate BlackBerry's prowess as a data security provider as the company has won numerous government contracts for its handsets, which indicates BlackBerry's capabilities in MDM and data security shouldn't be underestimated at the present moment in time.

I reiterate my earlier buyrecommendation, but have no price target in mind