BlackBerry Smartphone Business should be Shut Down says Wells Fargo

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BlackBerry‘s stock had its “market perform” rating reiterated by Wells Fargo in a research report issued on Monday. They presently have a $7.62 target price on the company’s stock. Wells Fargo’s price objective points to a potential upside of 10.27% from the company’s previous close.

Wells Fargo’s Maynard Um today reiterated the Market Perform rating on shares of the company arguing that shutting down its handset business would be its best course of action.

Um argues that the company’s sales of the BlackBerry Priv , the first smartphone by BlackBerry running Android, are proving “soft,” leading him to conclude that “success in the handset business, to us, seems like an uphill battle, particularly against companies with scale such as Apple and Samsung Electronics.”

“The attempt at the high end smartphone market appears to not have been successful with disappointing unit volumes.” “Hence, we are not overly optimistic about BlackBerry’s chances in the Android hardware market though nor is it embedded into our forecasts,” writes Um.

With Priv sales soft, this could accelerate a decision though we believe this isn’t necessarily all bad news as such an action would result in earnings accretion […] If our and Street forecasts are correct, BlackBerry would effectively have failed at its attempt to recover the hardware business and we believe the company will take a long hard look at de-emphasizing or shutting down its hardware business.

Um notes that BlackBerry CEO John Chen “has stated numerous times that he would look at strategic options if the hardware business failed to get to sustainable profitability.”

Um doesn’t think that the company will succeed even with forthcoming models of Android handsets:

“We note that AT&T has dropped Priv pricing from $699 to $639 and Sprint no longer plans to launch the Priv (an about face from earlier in the year). We believe the strategy change to attack the mid-range smartphone market will also be challenging as while the lower pricing (we anticipate pricing in the $400 range) would help to drive up some unit volumes, the mid- range market is highly competitive.

Nonetheless, we expect BBRY to address the mid-range market with two new Android-based smartphones this year – one with a keyboard and one without. BlackBerry’s differentiation, or the push it is to make, would be around security. However, whether a “more secure” smartphone push would be enough of a differentiator in a highly competitive market remains to be seen.”

Um notes argues that in a number of respects, the BlackBerry is not substantially “differentiated” from other Android devices, such as Samsung’s Galaxy S7 line.

And even the security features that BlackBerry has added are not enough:

“However, PRIV differs from other Android handsets as it contains a hardware root of trust, which verifies the Android OS with the hardware at boot similar to prior BlackBerry devices. It also has Verified Boot and Secure Boot Chain to verify every layer of the device to prevent tampering, and FIPS 140-2 full disk encryption.

PRIV also comes with DTEK, an app which monitors what parts of the phone various apps access (e.g. camera, location, messages, contacts, etc.). That said, a recent report cites an “executive at AT&T” as saying that the Priv “is really struggling” and that returns were higher than expected.”

Um estimates that shutting down the hardware division would lead to a drop of around $1.07 billion in FY17 revenue. However, he said that gross margin and operating margin would improve to 79.5% and 17%, respectively. This would drive FY17 earnings per share estimate to $0.27 as well as reduce balance sheet risk and volatility, the analyst said.

Um suggests that even with recent profit improvement, it makes sense to exit hardware:

“Management indicated that it had positive gross margins in hardware in FQ4 16 (implying gross margins were negative in prior quarters) and that it reduced its hardware operating loss by half in FQ3 16. We estimate hardware operating losses went from around -$150 million in FQ1 to -$70 million in FQ4 driven by 1) lower IP payment amortization, 2) higher gross margin from Priv sell-in, and 3) lower operating expenses from restructuring. Our estimate is predicated on the view that prior to FQ4 16, around 50% of BlackBerry’s R&D was related to hardware, 40% of sales and marketing, and 60% of depreciation and amortization (the latter of which we believe was related to the IP royalty amortization). While an operating margin loss improvement from -59% in FQ1 to -37% is a material move and we expect further improvement to -10% in F17 driven by further amortization roll off and further Priv sell-in, at still such a negative margin, we believe it makes more sense for BlackBerry to look at strategic options for its hardware business.

“We believe these losses, if they come to fruition, could prompt BlackBerry to pursue strategic actions,” 

Um is the second analyst to state that BlackBerry should shut down it’s smartphone business.  Just last month veteran Wall Street analyst Gus Papageorgiou returned from a two-year hiatus to warn investors the company’s handset unit is dragging down the business and should be shut down.

Papageorgiou covered BlackBerry for more than a decade and was extremely pro-BlackBerry. He commented at the time,

“It’s unlikely other companies are interested in acquiring the shrinking device business either, Shutting it down instead would boost profit margins,”

“We believe the market would applaud the company exiting the device business,”

Hedge Funds

Several hedge funds have recently added to or reduced their stakes in the stock.

Exane Derivatives purchased a new stake in BlackBerry during the first quarter valued at approximately $221,000.

Commonwealth Equity Services raised its position in shares of BlackBerry by 19.5% in the first quarter.  Commonwealth Equity now owns 42,279 shares of the stock valued at $342,000 after buying an additional 6,889 shares during the last quarter.

Ladenburg Thalmann Financial Services raised its position in shares of BlackBerry by 3.0% in the first quarter. Ladenburg now owns 67,596 shares of the stock valued at $545,000 after buying an additional 1,959 shares during the last quarter.

OMERS ADMINISTRATION raised its position in shares of BlackBerry by 12.0% in the first quarter. OMERS now owns 74,400 shares of the stock valued at $602,000 after buying an additional 8,000 shares during the last quarter.

Finally, Numeric Investors LLC acquired a new stake in BlackBerry during the fourth quarter valued at about $1,093,000.
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