BlackBerry's best hope for future is without BlackBerrys

Staff Writer
Columbus CEO

(c) 2013, Bloomberg News.

TORONTO — BlackBerry, shunned by buyers even at a record-low takeover valuation, may find that its best shot of survival is to abandon smartphones and bet its future on software.

A $4.7 billion buyout of BlackBerry fell through this week, and shareholder Fairfax Financial Holdings opted instead to infuse the company with cash to counter a burn rate that had been on pace to use up most of its stockpile by the end of next year. Jefferies Group said it's also unlikely that Waterloo, Ontario-based BlackBerry will find takers for any of its pieces.

John Chen, interim chief executive officer, could shut down the smartphone unit that's eating up BlackBerry's cash and focus on software for businesses, which can be profitable even though it's the smallest piece of the company, William Blair & Co. said. The median revenue multiple for software makers is about 3.3, compared with the 0.17 times sales Fairfax was willing to pay for BlackBerry, according to data compiled by Bloomberg. As long as the handset business is losing money and customers, there's no reason to own the stock, Nomura Holdings Inc. said.

"They should just exit the handset business," Anil Doradla, a Chicago-based analyst at William Blair, said in a phone interview. "It would look more like a software company. There's no guarantee of success for BlackBerry by embarking on this and it all depends on execution, but this option seems to be the most logical one."

After the $9-a-share deal with Fairfax collapsed, BlackBerry ended its sale process and replaced CEO Thorsten Heins with Chen, former chief of Sybase Inc. BlackBerry is raising $1 billion by selling convertible bonds, and Fairfax will invest $250 million in the debt, which can be turned into stock at a price of $10.

While the bond sale will help keep BlackBerry afloat, MKM Partners LLC's Michael Genovese said, it's a temporary fix.

"We see this capital raise as more symbolic than significant," the Stamford, Conn.-based analyst wrote in a Nov. 4 report. "We assume any cash on the balance sheet will eventually be burned and we give BlackBerry zero credit for cash in our valuation."

In addition to the cash infusion from the bond sale, BlackBerry is seeking a tax refund of as much as $1 billion from the Canadian government before the end of the year, according to two people familiar with the situation, who asked not to be identified because the discussions are private.

The company had $2.34 billion in cash and equivalents as of Aug. 31, as well as $225 million in long-term investments.

BlackBerry's $1.57 billion of revenue in the most recent quarter was about half the amount analysts were expecting, and the lowest since mid-2007. Costs of goods sold exceeded sales by $374 million, and it took a pretax writedown of $934 million for unsold phones. It also fired about 40 percent of its employees.

"As long as the company continues to sell handsets below cost and is unable to stem the decline in services revenue and subscribers, there's no reason to own the shares," Stuart Jeffrey, a New York-based analyst at Nomura, wrote in a Nov. 4 report.

Without sales of smartphones, BlackBerry won't be able to generate new service fees. Those fees accounted for $724 million of sales last quarter, 46 percent of total revenue.

Even so, the company could rely on legacy fees from existing users as it grows its device management business. BlackBerry had 72 million subscribers in June, down from 76 million in March. It has since stopped releasing that figure.

While there would be expenses associated with winding down the handset business, focusing on software could end up restoring profitability and growth, said Doradla of William Blair. That would mean jettisoning a unit that accounted for $6.65 billion, or 60 percent, of BlackBerry's revenue in the fiscal year that ended in March, while software generated just $261 million and services pulled in $3.91 billion.

"This is the best of the worst options" that BlackBerry has left, Doradla said. "One thing is certain: They should not be in the hardware business."

Asked in a Nov. 4 interview if he could rule out closing the handset business, Chen said that at this point he can't rule anything out. Adam Emery, a spokesman for BlackBerry, declined to comment on what the company may do with its handset business.

Chen, 58, was picked by BlackBerry because of his success in turning around software maker Sybase. When he took control of Sybase in 1998, the company was firing staff and its shares were trading near a record low. He sold it in 2010 to SAP AG for $5.8 billion, more than six times its value at the start of his tenure.

Asked which of BlackBerry's assets were the best to focus on, Chen singled out the company's software and security features. These include its mobile device management software for corporate clients, encryption software used by government customers, its patent portfolio and its BBM instant-messaging service, which is growing again and can be downloaded by iPhone and Android users.

"Device management is a huge opportunity for them and given his software background, this is something Chen has to look at more seriously," Ramon Llamas, an analyst at IDC in Framingham, Mass., said in a phone interview. "BlackBerry's security is the gold standard and it's something that Chen can really lean on and connect to the device- management business."

The company faces competition from closely held MobileIron and Good Technology, which already supply security software to customers whose employees use iPhones or Samsung Electronics devices. Good Technology's customers include Vodafone and AstraZeneca, and on the government side, the U.S. Air Force and Department of Homeland Security.

"Our best guess is that the software intiatives need the most push, the most focus," Peter Misek, a New York-based analyst at Jefferies, said in a phone interview. "The hardware business is going to be really, really tough for them to recover in. Chen has a herculean task in front of him."

Morphing into a software-focused company may lead to a higher valuation. BlackBerry's enterprise value Thursday was an 89 percent discount to its trailing 12-month revenue, while software companies larger than $100 million had a median multiple of 3.3, according to data compiled by Bloomberg.

Fairfax's bid for BlackBerry was just 0.17 times its sales, the lowest multiple on record among similar-sized acquisitions of North American telecommunications and technology companies, the data show.

A successful turnaround of BlackBerry's prime assets would potentially position Chen to sell them if he chose to, given those assets already hold value, said Alexander Peterc, an analyst with Exane BNP Paribas in London.

"There should be interested parties for the corporate e- mail part, the mobile device management platform," Peterc said in a phone interview. As is stands right now, "there's absolutely zero interest in the hardware side."

_ With assistance from Doug Alexander in Toronto.