CA - BlackBerry Stock: Overpriced Amid Spin-Off And Uncertainty

2023-10-05 14:50:37 ET

Summary

• BlackBerry Limited stock has declined 7.5% after announcing that it will spin off its Internet of Things division.
• Since this division has been BlackBerry's core growth driver, this does not bode well for the company's revenues, profits, or margin profile.
• Furthermore, BlackBerry stock's valuation is already relatively expensive. The downside implications of the divestiture could further worsen its valuation metrics on a relative basis.
• The picture here is highly uncertain but looks to be negative overall, and yields a sell rating for BB stock.

Overview

BlackBerry Limited (BB) stock is on the move following its announcement about spinning off its Internet of Things ("IoT") division. As is often the case with acquisitions and divestitures, BlackBerry stock has sold off significantly in the wake of this news. With the post-market news report yesterday, October 4th, today's trading day has seen BlackBerry stock decline 7.5% even as the NASDAQ Composite (COMP.IND) moved only half of a percent.

This precipitous decline has capped off a volatile year for BlackBerry stock, now bringing it below the NASDAQ Composite's price return year-to-date. While BlackBerry had fluctuated significantly throughout the year, today marks a new low relative to the index year-to-date. Given the situation at hand, this appears justified.

Indeed, the IoT business has been BlackBerry's core growth driver in recent years. This means that the overall enterprise is set to change materially as the divestiture of this business unit plays out. The question that investors must now ask is whether there's a reason to stay in this stock. While I don't want to jump to conclusions, I am fairly skeptical off the bat due to the pattern of secular decline that we have seen in BlackBerry's other business units. In this article, I'll review the situation in more detail while also commenting on the company's latest quarterly results.

BlackBerry Q2 2024 Earnings Results

The first thing to note with BlackBerry's fiscal Q2 '24 earnings (period ending August 31) is the performance of the IoT business unit. Revenues here increased 9% quarter-over-quarter, now totaling a $49M quarterly run rate. Gross margin remained robust and even ticked up further, coming in at 84% for the quarter for IoT. Growth remained particularly healthy within the automobile vertical ((QNX)), with 20 new "design wins" - contracts for installing the system in specific makes and models. Growth guidance for IoT is now set at 9% - 17% y/y. Overall, things look rosy for this part of BlackBerry. Of course, this division is set to be divested and repurposed into a new publicly traded entity; it won't remain a part of BlackBerry for too much longer.

As such, investors in this stock should now look to the company's results overall . Here the picture is not quite as presentable. Revenue dropped 21.4% y/y, with net income declining 22.2% along with it. Cash generated from operating activities declined 133% y/y, and levered free cash flow dropped 168.4%.

Overall, it's clear that BlackBerry's IoT business unit has not been able to turn the tide for the entire business, and that the ground looks shaky to say the least. These recent results inspire skepticism and lead me to advise caution around owning or purchasing the stock at present.

BB Stock Valuation

With that being said, we can further contextualize the situation by looking at BlackBerry's valuation. We must look to non-GAAP metrics, as the company is not profitable on a GAAP basis at present. Here we can immediately see that this stock is expensive. BlackBerry is trading at a 213.5 non-GAAP forward P/E multiple - roughly a 9x premium against the IT sector at large.

Furthermore, it's set to lose a significant portion of its profit due to divesting the very high-margin Internet of Things business. All else being equal, this will skew the multiple further. This effect is further reinforced by the fact that the IoT business unit has been the growth driver for BlackBerry. The other business units, namely cybersecurity and licensing, are holding flat or declining. This means that the divestiture will lower profits as well as the overall growth rate of the firm.

We can gain insight into these two factors (profits & growth rate) concurrently by looking at the PEG (price/earnings growth) ratio. This metric is calculated by taking the P/E ratio and dividing it by the expected annual EPS growth rate. Since the denominator in this metric is expected annual EPS growth, a lower number will thus make this number larger and indicate that the stock is more expensive on a PEG basis. Unfortunately, BlackBerry is already pricey on this basis.

This creates a doubly-worrisome situation for BlackBerry. As it proceeds to spin off the IoT business unit, it will lower its profits as well as its profit growth rate. This will make it even more expensive on a relative basis.

The one counterpoint to this may be the company's price/sales ratio. Here, BlackBerry trades at only a modest premium relative to the IT sector. With $825M of revenue on a trailing twelve-month basis, the roughly $200M decline from spinning off the IoT unit (annualized) should only increase this multiple by 25% or so. Nonetheless, it is too close to the sector median for me to say that it's discounted on this basis. Ultimately, this metric will also be affected negatively by the pending spinoff.

Overall, a review of BlackBerry's valuation indicates that it is still fairly expensive overall. Given the financial effects that it will see as a result of separating away its IoT division, this is a material concern.

Conclusion

BlackBerry has hit a rough patch, and there is a hefty degree of uncertainty around this stock. While there is significant promise with its IoT division and its pending IPO, I'll reiterate that owning BlackBerry stock is simply not going to grant investors upside exposure to that event. Rather, it is going to subject them to the negative valuation implications of it.

When we consider this in light of the fact that BlackBerry's valuation is already relatively expensive, the signs here point to selling. While there is the potential for a one-off benefit from BlackBerry divesting its IoT business unit as well as others, I would not recommend this stock to buy-and-hold oriented investors. At this time, I'm calling BB stock a sell.

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