EUR 850.00 For Business Accounts Only

Morningstar | Blackberry’s Purchase of Cylance to Accelerate Growth; Raising FVE to $11. See Updated Analyst Note from 19 Nov 2018

Blackberry announced its intention to purchase private cybersecurity firm, Cylance, for $1.4 billion in cash on Nov. 16. As we mentioned in our Oct. 4 note, the firm needs to make acquisitions as it will likely face difficulties in growing the top line organically. The acquisition announcement is consistent with Blackberry’s strategy to focus on providing enterprises with secure endpoint management technology. In addition, this purchase will accelerate top-line growth for the firm, which we were expecting to slow down after fiscal 2022 given the firm’s lack of economic moat sources. While we don’t expect the addition of Cylance to be accretive to the bottom line in fiscal 2020, we do foresee that its strong recurring revenue growth will drive margin expansion for Blackberry beginning in fiscal 2021. After adjusting our model based on this announced transaction, we are raising our fair value estimate for BlackBerry to $11 per share, up from $10. We continue to recommend a wider margin of safety before investing in this no-moat and very high uncertainty name as Blackberry shares are trading in 3-star territory.

The $.14 billion purchase of Cylance is likely to close by the end of Blackberry’s current fiscal year, which ends in February 2019. In terms of valuation, Cylance raised around $100 million in Series D funding in 2016 according to PitchBook, which implied a $1 billion valuation of the company. At $1.4 billion, it appears that Blackberry is paying 10.8 times trailing 12-month revenue as Blackberry management stated on the call that Cylance generated $130 million (a 90% year-over-year growth) in total revenue during fiscal 2018, which ended in April. Blackberry’s CEO, John Chen, also hinted that this deal could represent around 7 times forward sales, which indicates an expected $200 million in revenue for Cylance during the next 12 months, or a 54% annual growth. We view such multiples as appropriate given that we foresee Cylance revenue to grow at a 33% CAGR through Blackberry’s fiscal 2023. Plus, we expect that the addition of Cylance likely will further expand Blackberry's gross margin as most of Cylance’s revenue is recurring.

Cylance, which was founded in 2012 by former McAfee executives Stuart McClure and Ryan Permeh, is known for applying artificial intelligence technology, mainly machine learning, for early detection of threats to security on fixed and mobile endpoints. According to a 2017 research report by Enterprise Management Associates, Cylance is viewed as the market leader in next generation endpoint security (NGES) based on revenue. In our view, the addition of Cylance with its standing in the NEGS market will give Blackberry the opportunity to be the one-stop-shop for enterprises looking for unified endpoint management technology (UEM). Blackberry currently refers to its UEM platform as Spark, and the firm plans to commercialize it next year.

We also think Cylance could strengthen Blackberry’s QNX offerings, more specifically the Hypervisor which is a single platform that can be used in connected vehicles to separately manage their various operating systems, including those of HMIs (human machine interfaces). Cylance likely will enhance the security features of such a platform. We think this could help partially offset impact of other infotainment vendors, such as Google, gaining traction and taking market share from QNX. As a reminder, in September, the Renault-Nissan-Mitsubishi Alliance announced that it will begin using Google’s Android infotainment system in their cars after 2021.

After adding our estimates of Cylance revenue and accounting for its impact on Blackberry’s margins, we are raising our fair value estimate of Blackberry to $11 per share, from $10. We expect Blackberry’s total revenue to grow at a 20% CAGR through fiscal 2023, partially driven by the 33% average annual growth we foresee for Cylance. With a higher percentage of overall revenue driven by recurring streams, we think gross margin will expand to 87% from 72% in fiscal 2018 and the 78% that we have assumed for fiscal 2019. Cylance is not yet a profitable firm as it continues to invest in R&D and in expanding its reach into Europe, Asia, and other regions. For this reason, we do not believe the acquisition will be accretive to Blackberry’s bottom line in either this year or fiscal 2020. However, we do expect Cylance’s strong recurring revenue growth to begin creating operating leverage in fiscal 2021, which we project will drive operating margin to more than 20% in fiscal 2023, up from operating losses last year.