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BlackBerry's Rising Revenue Hides Real Challenges

By Herve Blandin – Updated Sep 26, 2019 at 12:55PM

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The company's results fall behind the growth of its addressable markets, and management may be too optimistic about its future.

The cybersecurity company BlackBerry (BB 14.00%) posted a strong revenue growth during its fiscal second-quarter results. But without the contribution from its recent acquisition, the endpoint security company Cylance, BlackBerry's revenue would have declined. And management's expectations for Cylance may not match up with reality.

Challenges in a growing market

BlackBerry reported non-GAAP revenue of $261 million during its second-quarter results, up 22% year over year. But this apparently solid growth is due to the extra revenue from its Cylance purchase at the end of February. Without it, revenue would have dropped to $210 million compared to $214 million the year before.

The decline in the company's Internet of Things (IoT) business -- which includes software and services that secure endpoints -- from $141 million to $134 million explains this underperformance. The company's Enterprise Software and Services (ESS) business -- a part of its IoT business -- caused these disappointing results. The company's financial statements don't detail ESS's performance. But the last company's earnings call revealed the ESS business was down in the mid-teens. And John Chen, BlackBerry's CEO, said that ESS's decline  sprang from the company's efforts to reorganize its salesforce.

Thus, according to management, the decline in the company's IoT business is temporary. But this deterioration is worrying for three reasons. 

First, BlackBerry's IoT revenue, at 51% of its total revenue, represents a significant part of its activities.

Second, revenue declined in the context of a fast-growing IoT market. For instance, IDC, a market research company, forecasted the number of IoT devices to grow at a compound annual growth rate (CAGR) of 28.7% between 2018 and 2025. And BlackBerry's latest presentation highlights 27% average annual growth in its IoT addressable market between 2018 and 2021.

Third, management didn't plan for or effectively manage the consequences of its sales reorganization. In the previous quarter, the CEO said that changes in the sales team were over – and in contrast with the recent ESS decline, he also said that business would post quarter-over-quarter revenue growth for the rest of the year.


Image source: Getty Images.

Cylance's shrinking market share

Besides the difficulties of BlackBerry's IoT business, investors should also pay attention to Cylance's performance in particular.

In its latest presentation, BlackBerry's management estimated that the endpoint security addressable market would grow at a CAGR above 30% between 2018 and 2021.  With 24% year-over-year growth during the last quarter, it appears that Cylance may have lost market share. And BlackBerry's guidance for Cylance's full-year revenue growth – in the range of 25% to 30% – stays below the market's forecasted growth.

Also, Cylance's revenue growth is decelerating swiftly. This quarter's 24% revenue growth pales in comparison to the previous quarter's 31%. And the midpoint of Cylance's full-year expected revenue growth of 27.5% looks even weaker when compared to its revenue growth of 283% and 90%+ in 2017 and 2018, respectively. 

Growing revenue at a constant rate from an expanding revenue base represents a challenge for any company. But Cylance's revenue growth deceleration may signal competitivity issues that could contribute to a further decline. For instance, despite its higher revenue base, Cylance's competitor CrowdStrike (CRWD 4.21%) grew its revenue at a much higher rate (60%) than Cylance during the previous quarter.

Why prudent investors should beware BlackBerry

Besides its worrying revenue growth deceleration below the expected endpoint security market growth, BlackBerry's Cylance business is facing challenges that management may not have fully considered. For instance, management highlighted Cylance's capabilities in artificial intelligence and machine learning. But this offering isn't unique. Many cybersecurity vendors such as Palo Alto Networks, CrowdStrike, Cisco, Fortinet, Check Point, etc. also developed cloud-based endpoint security products based on these technologies.

Besides, most of these companies propose a much broader security and integrated security portfolio, providing cross-selling opportunities BlackBerry can't compete with. For instance, Cisco and Palo Alto offer security devices such as firewalls or gateways.

Thus, investors should not rely on BlackBerry's guidance to decide whether it's worth buying shares in. Even if you set aside the company's difficulties in its IoT business and the growth deceleration of its Cylance acquisition, BlackBerry reported a GAAP loss of $44 million, after another loss of $35 million during the quarter before. The company's elevated selling, marketing, and administration expenses -- at 55% of its revenue during the last quarter -- are holding back its profitability.

With this context, prudent investors should stay on the sidelines.

Herve Blandin owns shares of Cisco Systems. The Motley Fool owns shares of and recommends BlackBerry, Check Point Software Technologies, and Palo Alto Networks. The Motley Fool owns shares of CrowdStrike Holdings, Inc. The Motley Fool recommends Fortinet. The Motley Fool has a disclosure policy.

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