In life, there is almost always a yin to a yang, a good to a bad, a silver lining to every dark cloud, and a Yankee to a Met. The situation that BlackBerry
(NASDAQ:BBRY) currently finds itself in is a prime example.
By way of background, my firm has been bullish on BlackBerry for more than a year. This was largely due to our belief that, in time, the new BB10 OS combined with BlackBerry’s secure network would create real value beyond the smartphone market…moving into the smart device
opportunity (QNX is a great OS for use in mission-critical applications in sectors such as automotive, health care, utilities, and so forth).
Our short-term thesis is that BlackBerry can drive revenue selling BB10 phones to its long-suffering BlackBerry fan base. It appears the BlackBerry faithful are stepping up, and initial demand for the new phone is solid. This is good and should drive several-to-many quarters of hardware revenue acceleration.
The contrarian argument is the loss of future Services revenue every time the company sells a BB10 phone to a BB6/7 consumer. The company receives monthly revenue for its BlackBerry Internet Service for every consumer that uses a BlackBerry pre-BB10 phone. (Note: BlackBerry also has corporate customers that use the BES service that (we believe) are not affected, but that number has been dwindling and is no longer the majority of BlackBerry subscribers).
This unfortunate turn of events requires a little math to determine just how profitable a BB10 phone sale really is to BlackBerry.
If the company sells a BB10 phone to a carrier at $500 each (a reasonable assumption), and that phone yields a 35% gross margin, BlackBerry receives approximately $175 in gross profit per phone.
If the phone is a replacement for a BIS-subscribed phone, which yields ~$4/phone/month ($4 being the average fee per phone when dividing BlackBerry’s Service revenue by its subscriber base), than the present value of that loss of future revenue runs from $90-$130 depending on the length of time one assumes the subscription will run (for our purposes, we’ll assume 24-36 months).
In other words, BlackBerry makes an immediate GP of $175, but loses $110 in future revenue. It’s also likely that the gross profit per phone will actually trend down over time, not up, as lower-end models are introduced to the market.
The revenue recognition is different, of course – the company can book the $175 immediately, but lose only $4 in pro-rated monthly Services revenue today. Thus hardware gross profit will surge up front, while Services revenue will retreat slowly over time.
The irony is that the more successful BlackBerry is at upgrading its customer base, the more revenue it will lose down the road. If we assume that BlackBerry’s $4 billion in Services revenue is cut in half in year two, and assuming the gross profit from the Services revenue is near 100%, than the company will have to sell 13 million additional phones to make up for the loss each year
Remember also that BlackBerry must still run/maintain its network for legacy BBM and BES, so costs are not coming down in tandem with BIS revenue.
The company does have an opportunity to earn new Services fees from MDM/MAM management with its new BES 10 Management platform. It also has the “smart device” management opportunity that can drive additional fees.
However, there is very little detail on how that’s going to play out, which gives us pause. Moreover, as longtime followers of the enterprise endpoint management market, the MDM/MAM opportunity is not only in its infancy, with few standards and immature technology, but there are already a host of software (and even hardware) competitors currently working to integrate MDM/MAM as part of a complete delivery, management and security package. Companies like Symantec
(NYSE:VMW), Citrix Systems
(NASDAQ:CTXS) and Microsoft
(NASDAQ:MSFT) have their eyes (and wallets) aimed at the new mobile management opportunity. Security vendors like Check Point Software
(NASDAQ:FTNT) and Websense
(NASDAQ:WBSN) are also competing for a share of that revenue. We recommend that investors keep BES10 management opportunity in perspective -- BlackBerry has a strong reputation for MDM, but is no longer alone in the market.
In summary, strong hardware sales and huge short interest make for an exciting short-term story. However, it’s important to be aware that the company is right at the beginning of a major change in its business model – a dark lining in a silver cloud.
Disclosure: Minyanville has a business relationship with BlackBerry.
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