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Blackberry - The Real Story

June 23, 2014 | About:
Grahamites

Grahamites

112 followers

Blackberry’s fiscal Q1 earnings came out last Thursday. The analysts were shocked to see a surprising profit from the same company who lost $4.4 billion just 2 quarters ago. Investors reacted positively to Blackberry’s results, which sent the shares higher since the earnings release. Everything seems to be on track for John Chen’s turnaround plan. “Our performance in fiscal Q1 demonstrates that we are firmly on track to achieve important milestones, including our financial objectives and delivering a strong product portfolio,” said John Chen, Executive Chairman and Chief Executive Officer of BlackBerry. “Over the past six months, we have focused on improving efficiency in all aspects of our operations to drive cost reductions and margin improvement. Looking forward, we are focusing on our growth plan to enable our return to profitability.”

First of all, I want to give credit to Mr. Chen for what he has achieved during such a short period of time. He executed quickly and well and the balance sheet has seemingly stabilized.

While in GAAP terms, the business seems to be doing much better than it was 6 months ago, the earning’s quality of Blackberry deserves some serious attention because in my opinion, Blackberry embarked upon a massive financial engineering started with Thorsten Heins and John Chen took it to another level.

In simple terms, the trick John Chen and his team deployed involved shifting future expenses to a specific quarter and took a big one-time charge. This includes the massive inventory write-off, PP&E impairment and intangibles write-off. On a smaller scale, Blackberry’s management team also conveniently used restructuring charge to mask some real operating expenses.

  • Inventory write-off – this served the purpose of lowering Q3 2014’s GAAP income but improving BBRY’s gross margins going forward as inventories were being carried on the balance sheet on a lower cost.
  • PP&E and Intangibles write-off – again, this lowered the Q3 2014 GAAP income but future quarterly depreciation charges would be lower.
  • Restructuring charge: while used properly, this should give investor a better picture of what’s recurring versus what’s not. But I suspect that Blackberry’s management has abused the use of restructuring charges by throwing in normal operating expenses into restructuring charges.

So, what’s Blackberry’s normal earnings? Here I’ve prepared a table which shows the GAAP numbers and estimated real numbers with explanations.

Reported GAAP Amount

Estimated Normalized Amount

Explanation

Revenue

$966

$966

Cost of Sales

515

628

See GM%

Gross Margin

451

338

See GM%

Gross Margin %

46.7%

35%

Account for the inventory write-down and Foxconn Deal. Prior to the write-down, BBRY’s GM was in the low 30s. The Foxconn deal improved GM but the extent is unknown.

Operating Expenses

R&D

237

237

SG&A

400

400

Amortization

81

393

Blackberry disclosed in Q3 2013 that estimated 2015 intangible amort is 971 million, or 243 million per quarter, prior to the massive write-down. Also PP&E amort was running at about 150 million per quarter prior to the write-down.

Debenture FV Adj

-287

0

Fluctuations in Fair Value of the Convertible bonds, not core operating earnings.

Total Ope Exp

431

1,030

Operating Income(loss)

$20

-$692

Now we can tell that without the financial engineering, Blackberry could have been reporting a close to $700 million quarterly loss instead of a $20 million GAAP income. This is without considering the effect of restructuring charge, which would increase operating expenses and lower operating income even further. Such is the shortcomings of GAAP and reported numbers.

Let’s not forget about the real cash flows. Here Blackberry acknowledged that without the tax refunds and real estate sales, it actually used $255 million of cash instead of an increase of $429 million. The difference is $684 million, which is fairly close to the difference between GAAP earnings and normalized earnings. I don’t think this is a pure coincidence.

John Chen’s financial engineering has made it a lot easier for him to report good numbers in the following quarters. If you are a Blackberry shareholder, you should do this exercise every quarter to understand the real progress of the turnaround.


Rating: 4.9/5 (16 votes)

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Comments

maurodejesus
Maurodejesus premium member - 1 month ago

Thanks for the instructing article! One thought: I think its almost impossible right now to estimate a normal earning power, because the business is sorrounded with uncertainty. They are developing new products, focusing on enterprise services, internet of things, etc. And because of that, probably neither the GAAP numbers nor your estimated normalized amount are good indicators of the future.

Regards

Grahamites
Grahamites premium member - 1 month ago

Maurodejesus - Thanks for your comments. You are right, it's impossible to estiamte Blackberry's earnings power. I should have used the term normalized earnings instead of earnings power. Thanks for pointing that out. I also agree that it's too hard to project the future.

vgm
Vgm - 1 month ago

Grahamites -- as a BBRY shareholder it was really interesting to read your piece. I'm in agreement with Mauro and you that it's difficult/impossible to project figures based on the past. For all intents and puposes, this is a new company. I therefore would argue we need to use second-level thinking in assessing BB as an investment - the softer, more qualitative parameters.

The turning point for me was the arrival of John Chen. My view of him is as an Outsider-like CEO who's an outstanding operator and capital allocator. The turnaround he executed at Sybase, rescuing it from the dead into a remarkable success, was of the highest caliber. It has similarities to the task at hand at BB.

So, to me, the REAL real story at BB is John Chen! He's a rare CEO who can be believed and trusted. He's the jockey who's capable of maximizing current assets, stemming losses, and building for the future. He's promised and reaffirmed BB will be cashflow breakeven by Feb 2015, and profitable in the following 12 months. He's already ahead of schedule. He has a solid plan and a vision. Part of his vision is the key role BB can play in the coming Internet of Things (IoT), an estimated $multi-trillion market. In his presentation last week to investors, he gave an excellent overview of the four pillars upon which he's re-building BB: Devices, BBM, Enterprise Services, and QNX. It begins at minute 22:

http://edge.media-server.com/m/p/frvuf7f6/?token=6jtrjb7njlwhqly1r6r37289gu7or448o1dtjrogjuurs5vm2079006

I took a significant position in BBRY a couple of months ago after the stock dropped below $8 (cost basis $7.4)

Thanks again for the stimulation. I'll be looking out for the warning signs you described.

Grahamites
Grahamites premium member - 4 weeks ago

Vgm - Thanks for your comments. I am not opining on the future direction of Blackberry's stock. As I pointed out in my article, I am just saying John Chen has made his job much easier when he took the big bath accounting. Blackberry has stabalized the balance sheet and John Chen is a very very smart and solid CEO. His execution ability is one of the best. There are a lot to like about the current BBRY but at the same time, some caution is very needed. It is a different business with a different business model now. I think your investment may work out very well.

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