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Morningstar | BlackBerry Fiscal 2Q Numbers Beat Expectations; Maintaining $10 FVE; Shares Fairly Valued

BlackBerry’s second-quarter fiscal 2019 results came in slightly above our projections and consensus. The firm’s higher percentage of recurring revenue drove further gross and operating margin expansion. While we were pleased with BlackBerry’s numbers, we note that the firm’s QNX, the main software and services revenue growth driver, may be facing stiffer competition on the infotainment side, which is one reason why we still view BlackBerry as a no-moat firm. Management maintained its guidance, and we haven't made any significant changes to our model and are maintaining our $10 per share fair value estimate. While the market welcomed the firm’s quarterly results by pushing BlackBerry shares 12% higher, the stock remains at 3 stars, and we would still recommend a wider margin of safety before investing in this no-moat and very high uncertainty name.

With continuing growth in BlackBerry Technology Solutions, or BTS, which includes the firm’s QNX offering, BlackBerry’s software and services revenue grew 4% from last year and 2% sequentially. While the firm has expanded its partnerships and overall sales channels for QNX, it remains heavily dependent on QNX infotainment offerings. We think the firm’s infotainment will maintain its market leadership position, but note that other players such as Google’s Android are gaining traction, as indicated recently by the Renault-Nissan-Mitsubishi Alliance announcement on Sept. 18th.

BlackBerry’s enterprise and software sales, which accounts for 47% of the firm’s overall software and services revenue, declined 3% year over year but increased 11% sequentially. The decline from last year was due mainly to the firm’s recognition of this revenue ratably, which began last quarter. The sequential growth could be an early indicator that enterprise and software sales will show year-over-year growth beginning in fiscal 2020. Plus, as BlackBerry continues to reach agreements with different U.S. government agencies, we think the firm’s enterprise and services client retention will strengthen, as those agencies may be facing switching costs when considering a change of vendor. In addition, there is still growth potential for BlackBerry’s enterprise and services within sectors such as healthcare.

The firm’s licensing and IP revenue, 38% of software and revenue services, was flat year over year and down 11% sequentially. While lack of growth was disappointing, more than 50% of this revenue is recurring, which bodes well for further operating leverage for the firm. According to management, around 81% of the firm’s total software and services revenue is recurring, up from 79% last year.

Higher recurring revenue pushed gross margin 200 basis points higher year over year to 78%. With higher gross margin and some cost control, mainly in research and development, the company’s GAAP operating margin of 19% came in much higher than last year’s 9%. We expect further operating leverage, driven by more recurring revenue and the five-year 17% software and services revenue CAGR that we have modeled in, which we project will expand GAAP operating margin to 33% by fiscal 2023, from a loss last year.