This BlackBerry Ltd. Business More Than Doubled Last Year

BlackBerry is known for its handsets, including the PassPort. But its future is likely to depend on its software. Source: BlackBerry.

BlackBerry's business is shrinking. The company's revenue declined just over 35% last year on an annual basis, as it shipped increasingly fewer handsets.But not every portion of BlackBerry's business is in decline: The Canadian mobile firm is seeing increasing demand for its software and services. Last year, revenue from BlackBerry's software and services rose 99% on an annual basis, climbing to $494 million from $248 million in its 2015 fiscal year. On an adjusted basis, it more than doubled, rising to $527 million.

BlackBerry's future seems increasingly tied to its software. For investors, the state of BlackBerry's software business is emerging as the most important factor driving the company's results.

Enterprise mobile management and securityBlackBerry's software and services business centers primarily around enterprise mobility management (EMM), where the company is the market leader with 19% market share. BlackBerry's BES12 gives IT departments the tools they need to manage and control the mobile devices of their employees, primarily smartphones. BlackBerry has its own proprietary mobile operating system, BB10, but its EMM solutions work across all platforms, including iPhones and Android devices. BlackBerry has used acquisitions in recent quarters, including AtHoc and WatchDox, to strengthen its EMM offerings, and now offers enterprises secure messaging and document management. Last year, it acquired Good Technology to bring additional security enhancements to its EMM solutions.

BlackBerry also includes revenue from its QNX business in its software and services. QNX is BlackBerry's embedded operating system. It's primarily found in automotive infotainment systems, where it powers about 50% of the cars on dealer lots. BlackBerry hopes to expand QNX's presence over time, leveraging the growth of connected devices broadly known as the Internet-of-Things.

BlackBerry also includes revenue from IP licensing in its software and services business, and has recently entered the cyber security consulting market. BlackBerry's IP didn't generate any revenue for the company in the fourth quarter, and its security consulting effort remains in its infancy. Still, management believes both could accelerate over time and drive additional sales.

A bigger part of BlackBerryGrowing demand for its software should benefit BlackBerry's shareholders. Last quarter, BlackBerry's gross margin came in at 48.7%, up from 44.9% on a sequential basis. BlackBerry's management attributed the improvement to its growing software business.

In total, BlackBerry believes that its software and services revenue will grow 30% in its fiscal year 2017 (which began in March). That won't be as impressive as its 106% surge last year, but it would make it a more meaningful portion of the larger BlackBerry business. Software and services generated just under 23% of BlackBerry's revenue last year. Analysts estimate that BlackBerry will generate $2.67 billion in revenue this year. If they're right, and BlackBerry's guidance proves accurate, software will account for about 26% of BlackBerry's 2017 fiscal year revenue.

Forget about phonesThat means that the bulk of BlackBerry's revenue will still come from its handsets and service access fees, as it did in fiscal year 2016. But at some point in the future, it's likely that the overwhelming majority of BlackBerry's sales will come from its software and services.

Revenue from BlackBerry's service access fees has been declining for years, and BlackBerry expects it to continue (it's modeling a 18% drop this quarter). These are the fees BlackBerry charges carriers to manage data for its older BB7 handsets, which are increasingly falling out of favor. At the same time, it's new phones aren't finding much in the way of success. BlackBerry recognized revenue on just 3.2 million smartphones last year, down from 7 million in the year prior.

CEO John Chen has admitted that the company could be forced to exit the handset business in the future if it can not make the division profitable. BlackBerry has been loathe to do this, as it believes its brand is intrinsically linked to its history as a maker of secure smartphones. Even if enterprises aren't using its devices, they may trust the BlackBerry name because they understand its reputation, and thus be willing to purchase BES12 or other EMM solutions for their handsets. In an effort to stimulate demand, BlackBerry will release cheaper phones going forward, but competition in the smartphone market is brutal.

Most likely, at some future date, BlackBerry will stop making handsets and its service access fees will dwindle away to almost nothing. When that happens, the company will become a provider of mobile software. It remains to be seen if growing software demand can offset the decline of its other businesses, but it's the one aspect of BlackBerry investors should turn their attention to.

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