I have been keeping a close eye on BlackBerry Limited (NYSE:BB) for over two years after being attracted to the company’s turnaround potential in early 2021. Unfortunately, though, BlackBerry has been struggling to gain traction with its turnaround strategy due to various reasons, including a seemingly poor go-to-market strategy for the cybersecurity business. The IoT business has shown some strengths, as expected, but I hold the view that this business segment alone will not help the company come out of the woods in the foreseeable future.
Since my most recent article, BlackBerry stock has gained close to 8%, but I believe it is too early to ride this momentum with the upcoming earnings report (expected Thursday, September 28) likely to shed light on the lingering challenges the company is facing. After digesting the preliminary earnings report, I am downgrading my rating on BB stock to sell.
Losing IoT Momentum Will Hurt BlackBerry
The bull case for BlackBerry has gained widespread coverage on Seeking Alpha over the last few years, and the story is centered around the company penetrating the mass market for its cybersecurity solutions while continuing to make inroads into the lucrative IoT opportunity by forming strategic partnerships with auto manufacturers. This story sounds simple and clean, but in reality, BlackBerry faces several roadblocks that prevent the company from executing this plan to perfection.
One of the major risks that I have previously highlighted is the possibility of the IoT business losing momentum, exposing the company’s vulnerabilities further. Despite revenue losses in the cybersecurity segment, the IoT segment has held up reasonably well over the last few quarters, but this has come to an end. According to the preliminary financial results published by the company, the IoT segment is expected to report $49 million in revenue for the fiscal second quarter, which would register a YoY decline of around 4%. The company also slashed its guidance for full-year revenue expectations for the IoT segment from a midpoint of $245 million to $232.5 million. As explained by the company management, these lackluster revenue expectations for the IoT business are the result of automakers delaying software deployments amid uncertain macroeconomic conditions.
With auto production continuing to be disrupted by supply-chain challenges including semiconductor shortages, I do not see BlackBerry’s IoT business recovering meaningfully in the remainder of this fiscal year. Even more concerningly, the expected weakness in the IoT segment will bring to light the fundamental challenges faced by the company’s cybersecurity business. BlackBerry faces challenges in gaining market share against larger incumbents in the cybersecurity market. BlackBerry does not seem to be benefiting from quantifiable competitive advantages, especially in its endpoint management, endpoint security, and embedded systems software solutions. The highly fragmented nature of these markets makes it difficult for BlackBerry to establish meaningful competitive advantages, and I do not believe these struggles will cease to exist in the foreseeable future.
The lack of diversification in the cybersecurity segment will also come into the spotlight with the company’s upcoming earnings report. According to the preliminary earnings release, BlackBerry’s cybersecurity segment will report $80 million in revenue for the quarter compared to $111 million in the corresponding quarter of the previous year. This substantially worse-than-expected performance is attributed to certain large government deals not closing as expected during the quarter. Although it is easy to dismiss this as a one-time occurrence, I believe this sheds light on a deeper problem that lies within the cybersecurity business. BlackBerry, so far, has failed to tap into the mass market opportunity for the cybersecurity business which remains concentrated on a few key clients including government agencies. For the time being, expecting BlackBerry to benefit from the favorable outlook for the cybersecurity sector is a gamble more than a justifiable conclusion based on company fundamentals as BlackBerry is still grappling to get its marketing strategy right.
The Full-Year Guidance Fails To Make A Lot Of Sense
After acknowledging the failure to close certain government cybersecurity contracts, the company, on September 6, reiterated the full-year revenue outlook for the cybersecurity business. This decision was based on the expectation for these government contracts to be closed in the remainder of the current fiscal year. Although reiterating the revenue guidance for the cybersecurity segment does not seem irrational considering this expectation, I believe it masks the probability of a similar occurrence in the future where the company may fail to renew certain contracts or close deals on time. The increasing competition in the cybersecurity sector may result in more delays in closing contracts as well, which is a risk that is not baked into BlackBerry’s current market valuation, in my opinion.
The company’s ability to recover lost revenue in the back half of the current fiscal year is crucial to maintaining some momentum with its turnaround strategy. A continued downturn in this segment could significantly impact the company’s financial results, and thereby deteriorate investor sentiment toward the company.
Even in the long run, I believe gaining market share in the cybersecurity segment will be an uphill battle. The company faces competition from larger players like Microsoft Corporation (MSFT), International Business Machines Corporation (IBM), and Symantec, which have significantly more resources and R&D budgets than BlackBerry. Gaining market share in this fragmented, competitive niche is easier said than done, and I believe BlackBerry does not have technological superiority over any of its peers to suggest the company will enjoy competitive advantages in the cybersecurity domain in the future.
Things To Look Out For In The Upcoming Earnings Release
When BlackBerry reports earnings this Thursday, I will be keeping an eye on a few important metrics and discussions.
- Management commentary regarding the failure to close some government cybersecurity contracts on time as expected.
- Management’s view about the path toward achieving organic revenue growth in the foreseeable future. The company has aggressively engaged in M&A activity in the last decade to emerge as a software company after its fallout in the mobile phone market but this is no longer a viable strategy. More clarity is needed here.
- A detailed discussion about the reasons behind the management’s decision to slash IoT revenue projections for the current fiscal year.
Takeaway
After maintaining a hold rating on BlackBerry stock for quite some time, I am now inclined to downgrade BlackBerry to a sell rating amid the persistent challenges the company’s cybersecurity business is facing and the new challenges seen in the IoT business segment. Even in the best-case scenario, I believe BlackBerry’s turnaround story will take several years to show any promising signs, and I am not ready to take on the risks associated with investing in the company in the absence of any catalyst that could trigger a positive turn for BB stock.
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