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This Is the Business BlackBerry's Shareholders Should Worry About

By Herve Blandin – Jun 28, 2020 at 10:00AM

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The cybersecurity specialist's fiscal first-quarter results revealed a significant weakness.

Unsurprisingly, BlackBerry (BB 0.70%) posted weak fiscal first-quarter results because of its automotive business as the industry has been facing headwinds because of the coronavirus pandemic. Besides these (hopefully) short-term challenges, investors should actually worry about the disappointing performance of the company's endpoint protection solution Cylance, acquired in 2019.

Challenges in the auto sector

BlackBerry's fiscal first-quarter revenue dropped 20% year over year to $214 million, slightly below analysts' forecast of $216.8 million.

In a press release, management indicated the revenue decline was due to macro headwinds in the auto and other embedded sectors. Indeed, the company's fiscal first-quarter covers the months of March through May, which saw a full period of coronavirus-induced lockdowns across the world.

The company's QNX services and software solutions now equip more than 175 million cars, which represents an important part of the more than 500 million endpoints the cybersecurity specialist protects. Logically, the challenges in the auto industry during that time frame had a negative impact on BlackBerry's results. 

Man is unlocking a virtual locking mechanism to access shared cloud resources.

Image source: Getty Images.

Worrying Cylance performance

As of this quarter, revenue from Cylance is included -- and hidden -- in the company's larger software and services segment. That segment, which also includes QNX and other solutions, represented 72% of revenue during the last quarter (the rest being mostly licensing).

But during the earnings call, CEO John Chen revealed Cylance's first-quarter revenue decreased to $49 million, down 4% year over year. That revenue decline should worry investors, as it contrasts with the strength of the endpoint protection market.

According to a study from MarketsandMarkets, the endpoint protection market should grow at a compound annual growth rate of 7.6% by 2024, which suggests BlackBerry is losing market share.

In addition, given the work-from-home policies enforced worldwide over the last months, several cybersecurity competitors have reported a surge in demand for endpoint protection solutions, boosting their revenue growth. As an illustration, in early June, the cloud-based endpoint protection specialist CrowdStrike posted better-than-expected year-over-year revenue growth of 85%, thanks to the ease of deployment of its software-as-a-service (SaaS) solution.

And more generally, a study from J.P. Morgan shows 36.9% of surveyed enterprises positioned endpoint protection in their top-three cybersecurity priorities this year, up from 33.6% one year ago.

Besides Cylance's subpar revenue growth, BlackBerry announced a goodwill impairment charge of $594 million, which indicates management took into account lower-than-expected long-term returns from some of the company's assets. The quarterly Form 10-Q filing (not published yet) will provide more details, but I estimate there's a fair chance that part of that writedown is related to Cylance's poor performance. The $1.4 billion purchase of the endpoint specialist in February 2019 had increased the company's goodwill by $899 million to $1.4 billion.

That weak performance could also have a negative impact on the company's other businesses as a lower-than-expected installed based of Cylance endpoint solutions will diminish the potential for cross-selling opportunities between BlackBerry's products.

What does this mean for investors?

During the earnings call, Chen said he would expect double-digit revenue growth after the coronavirus situation settles. And management aims at drastically improving the company's operating margin to a range of 20% to 25% over the long term, compared to only 1% during the last quarter.

If these goals materialize, BlackBerry's stock looks cheap. The market values the company at a low enterprise value-to-sales ratio of 2.8, based on analysts' forecasted next-year revenue, which contrasts with CrowdStrike's lofty ratio of 38 due to its stellar revenue growth.

However, investors should take management's goals with a grain of salt.

Last year, revenue growth of 20% came in well below the revenue growth guidance range of 23% to 25%. And in addition to Cylance's disappointing performance, management withdrew its expectation of delivering $100 million of cumulative revenue from its BlackBerry Radar asset tracking solution over the next three years.

Lastly, the company didn't issue any guidance, which doesn't give much confidence in a strong recovery over the short term. In contrast, several cybersecurity players, such as CrowdStrike, raised their full-year guidance given the boost that stay-at-home policies represented for their SaaS businesses.

Thus, investors should wait for growing revenue and improving margins to become a reality before considering buying BlackBerry's apparently cheap stock. And given Cylance's weak performance in the thriving endpoint protection market, I'm not willing to take that bet.

Herve Blandin has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends CrowdStrike Holdings, Inc. The Motley Fool recommends BlackBerry. The Motley Fool has a disclosure policy.

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