Monday, September 30, 2013
An open letter to BBRY management and directors
I have long been a BlackBerry (BBRY) supporter (or more recently that might be more accurately referred to as an apologist), as both a BlackBerry user (since 2004) and a Canadian. Over the years I’ve been invested on the short and long side of the company (no material positions in the company at this time), but regardless of my positions (or lack thereof) in the stock I’ve always closely followed the company and its strategy (or lack thereof). Due to the recent decision to not hold a conference call and the overall poor quality of management and board of director decisions I feel the need to post an open letter in an effort to get some answers.
First, a bit of history; Research in Motion (RIM, as BlackBerry used to be called) was the first company to release a smartphone (a phone capable of browsing the Internet, reading emails, etc). Their initial consumers were professionals (i.e. politicians, bankers, lawyers, doctors, etc) and government agencies. They rode the success of their flagship product, the BlackBerry, to a share price of around $150CDN (summer 2008) a double from their price in summer 2007, the approximate time the first iPhone (their first serious competitor) was released. Despite the increased competition, RIM maintained its stranglehold on the corporate market and continued to grow its user base as it sold older model phones into less developed economies (i.e. China and India) allowing revenues to grow until FY2011 where they peaked at $16.4 billion US (handset revenue).
Despite dramatically increasing revenues from the time of the iPhone release through to 2011, RIM (as it was still called) was repeatedly being told that it was irrelevant and its devices were a thing of the past. The Globe and Mail recently published an article that goes into great detail on the threat that the iPhone posed and how RIM planned to respond to it. As part of that response RIM released the BlackBerry Storm in 2008, an all touch screen device that would subsequently become their worst selling form factor (all touch screen) of any that they had ever introduced. Despite the poor sales they introduced a Storm 2 in 2009 to further poor sales, a Storm 3 (which they had rebranded Torch 9850) in 2010, and finally a Storm 4 (Torch 9860) in 2011. Despite living in Toronto, which seems to have the highest per capita BlackBerry usage of any city in the world, I have never seen a Storm (1, 2, 3 or 4) being used by an actual person. In 2011, the BlackBerry Playbook (which was shipped with several problems), an all touch-screen tablet sized device was released to, once again, poor sales. With their wallets consumers had voted five successive times and determined that an all touch screen BlackBerry was not something they wanted. Bear in mind that all this occurred from CY2008 to CY2011. A period where RIM handset revenue increased from $4.9bn US (CY2007 approximately) to $14bn US (CY2011 approximately), so people were buying (en masse) RIM’s keyboard phones.
Mere weeks after the release of their BlackBerry 7 platform, an announcement was made that the company was changing the operating system of the BlackBerry phones to a more modern one based on QNX, a company RIM acquired in 2010. Their initial goal was to release a series of new devices based on this BlackBerry 10 platform (as it was called) sometime around fall 2012. In the meantime they would completely cease development on the old Java based platform and not release any new phones until BlackBerry 10 was completed. Importantly, BlackBerry 10 was supposed to be an amazing upgrade over current BlackBerrys and be available in fall 2012, heavily incenting a delay in purchasing an existing model BlackBerry to wait for the new BlackBerrys. BlackBerry 10 was delayed a couple of times and did not make it to market until April 2013. Accordingly sales dropped by over 50% in CY2012 versus CY2011.
Due to the poor stock market performance of the company since 2008, co-CEO’s Mike Lazaridis and Jim Ballsilie reduced their salaries to $1 each until things had been rectified. Ultimately unsatisfied with the gesture, shareholders and the board of directors removed the co-CEOs and replaced them with Thorsten Heins effective January 2012. Mr. Ballsilie, who had been primarily in charge of sales, subsequently left the company completely while Mr. Lazaridis, who had been primarily in charge of engineering the devices, left in mid-2013. Mr. Heins was tasked with, and paid handsome bonuses, for bringing BlackBerry 10 to market (albeit approximately half a year later than anticipated). He is also primarily responsible for the Z10, an all-touch screen device (their sixth), being marketed as BlackBerry’s (the company’s name was changed) flagship product.
Finally, Prem Watsa, CEO of Fairfax Financial Holdings, took a large stake in BlackBerry (approximately 10% of share outstsanding) and joined the board of directors in January of 2012. He subsequently left the board in August of 2013 when the company put itself up for sale. It should be noted that the company had hired JP Morgan and RBC to examine strategic alternatives for the company a year earlier, but hadn’t officially put themselves up for sale. Despite not reporting anything material on the strategic alternative front, both JP Morgan and RBC were once again hired to consult in the sale process.
My view is that the buck has to stop somewhere, and in this case it has to rest on senior management and the board of directors at BlackBerry. With that, and the lengthy pre-amble, in mind I have several questions for BlackBerry’s senior management and board, which I have divided into categories:
1. Why was it decided to announce BlackBerry 10 in October 2011, weeks after the release of your latest BlackBerry 7 devices? While it is known that certain companies will always release new version of their product, it is highly irregular for them to declare their newest products obsolete immediately after release (i.e. Apple has not even mentioned the iPhone 6, despite the fact that we know it will be released next September). This announcement definitely impacted my buying intentions, and based on your CY2012 revenues, the buying intentions of most of your customers.
2. What, if any, market research was done with your existing customers? Specifically with regard to the ease of use of swiping versus having dedicated buttons (i.e. the call, hang up, BlackBerry, and back buttons of previous models). Also was any market research conducted as to how long it took an existing BlackBerry user to adapt to the new operating system? Most feedback that I have received from BlackBerry users is that they used the BlackBerry because they didn’t want to learn something new and they enjoyed the keyboard. The Z10 removed both of those advantages for existing customers.
3. Why was the decision made to remove all buttons (i.e. call, hangup, back, etc) from the phones in favour of the swiping method? Swiping seems far more complex than similar offerings from Apple and Google, and has contributed to the low overall sales. Even the iPhone, praised for its beautiful and elegant design, has a hard button for “home”.
4. Why was it decided to release the Z10 prior to the Q10? Given the products that have had success in the marketplace (iPhone and Android) it certainly made some sense to leverage BlackBerry 10 and create an all touch screen phone, however, given BlackBerry’s own poor experience with all touch screen devices this decision (launching the Z10 first) doesn’t make much sense. As mentioned in the pre-amble Z10 was your 6th all touch screen device, and your 6th straight sales disappointment (to put it mildly). How can it possibly take six times to learn one lesson? BlackBerry users do not like all touch screen devices! The decision to release the Z30 as your next product also seems to indicate that BlackBerry management still doesn’t get it.
5. Why was it decided to build so many Z10s? Once again, given the poor performance history of BlackBerry all touch screen devices, it seems illogical to risk so much on their success. The most recent write down of nearly $1 billion, attributed in the press release “primarily to Z10s”, indicates that BlackBerry ordered several million more than were demanded by the market. Pre-orders for all devices with all carriers were available, so a demand picture should have been easy to create. Further, if you underestimated the number of units you needed and actually sold out of Z10s (or Q10s) it would only serve as free advertising (as it does every year with iPhone’s newest release).
6. Was a Torch (slider keyboard) phone ever considered for BB10? Of the new products released this decade (2010), I would estimate that your high end products sold in the following order: Bold (touchscreen series), Torch (slider keyboard series), Q10, Playbook, Z10, Storm (Torch series). Given those sales wouldn’t it have made more sense to pursue a slider keyboard form factor for the Z10 rather than the all touch screen form factor? Not only did the Torch outsell the Storm, but a slider keyboard would have at least been a differentiating factor. The current Z10 (other than the hard to master swiping system) has no differentiating characteristics between it and products from Apple, Samsung, Motorola, Nokia, HTC, LG, Sony, etc.
7. Why was app availability so poor? The Z10 was the flagship product and as such, BlackBerry was making a concerted push toward the consumer market (arguably at the expense of the corporate market). Given this push toward the consumer market it was/is absolutely necessary to ensure that “key” apps are available to users. For example, Instagram is arguably the most popular non-gaming app among the key consumer demographics (teenagers and twenty-somethings). Facebook, Twitter, etc can be accessed by any mobile device through the browser and do not require a dedicated app. Instagram, however, requires an app in order to be able to upload photos. Without the ability to use Instagram, BB10 products, are dead in the water for that demographic. On the professional side, one of the most popular apps for BlackBerry, Bloomberg, just became available in the past few weeks (6 months after launch).
8. Why was corporate roll out so poor? BlackBerry’s initial success had come from large corporate customers. These are generally the best customers because they are more performance sensitive than price sensitive. However, in Canada (where BlackBerry adoption is highest), some of the largest institutions still have no approved BB10. Logic would seem to dictate that months prior to the launch of BB10 and BES10 that your largest corporate customers would have been given access to devices and test servers so that your initial rollout could include as many corporate customers as possible.
9. Why was the marketing of the devices so bad? Specifically the initial ads that aired surrounding the release of the Z10 were incomprehensible. As a Z10 owner (at the time) I was not sure what a man gymnastic tumbling through various scenes while holding a Z10 had to do with the phone and neither did your potential customers. To me this speaks to the misunderstanding of Apple’s general success. They were successful because they are a brilliant marketing company disguised as a technology company. Their ads (similar to BlackBerry’s more recent ads) have always clearly depicted what their device does well and how you can use it in your life. Also using Alicia Keys as “director of corporate creativity” or whatever the title was, was an unusual move. Would it not have made more sense to get a Justin Bieber or Taylor Swift (as distasteful as either option may have been) as they both have extremely large followings amongst the most impressionable audiences (adolescents)?
10. What was the marketing budget of the Q10 versus the Z10? By quarter if possible.
11. What are your actual unit sales in North America and Europe for the Q10 and Z10? And how many did you build of each and at what time?
12. Why did you bother to change the company name? Most consumer product companies are not named for the product. Apple sells iPhones, not iApples, Dell sells Optiplex workstations, HP sells Envy laptops, etc. It seems like a needless distraction that accomplished very little in terms of brand awareness. The only logical reason for changing the name would be some remote hope that users wanted to invest in the company but were too confused to determine that the ticker RIMM corresponded to BlackBerry products.
1. Do you feel compensation at the C-level was commensurate with performance? Mr. Heins, the CEO, received compensation of approximately $10mm in each Fiscal 2012 and Fiscal 2013 (basically CY2011 and CY2012 respectively). The other C level executives, some brought on by Mr. Heins, averaged approximately $4mm in total pay during Fiscal 2013. FY2013 was arguably one of the worst in company history as it experienced its first loss in years, a drop in revenue of over $7bn US, its first ever drop in total subscribers, and delays on its key product launch.
2. Do you feel that Mr. Heins interests were adequately aligned with shareholder interest, specifically with regard to his “new deal”? From what I can see in public filings, Mr. Heins has generated the majority of his wealth as an employee of BlackBerry, having gone from a job that would likely pay low six figures in 2007 to a multi-million dollar job (COO) in 2011, and finally CEO in 2012 ($10mm/year). His original deal as CEO would have seen him earn less than 2x his annual salary and bonuses in the event of a takeover, however, his new deal sees him earn over 5x his annual salary and bonuses in the event of a takeover (and his termination). This is amount does not seem to be based on the takeover price, but simply that a takeover occurs. The easiest way for a takeover to occur would be for the share price to be as low as possible, aligning Mr. Heins best interest directly opposite that of shareholders.
3. When Mr. Heins “new deal” was announced it was done to “retain and reward” him, given the poor financial performance of the company was this necessary? As the terms of his deal were laid out just a year prior, it seems odd that such a large increase in pay (and parachute) was required in order to retain his services. The poor performance of BlackBerry’s products in the marketplace and the general consolidation of the wireless handset industry also makes it seemingly less likely that a competitor would be interested in his services (at least in a position that would pay $10mm/year after easily achievable bonus targets were met).
1. When did the board decide to materially change how it accounts for handset sales? By changing handset sales from sold to channel to sold to users, this quarter appeared to have particularly low sales relative to previous quarters. This could dissuade other potential bidders or prevent investors from making an informed decision when they vote on Mr. Watsa’s takeover proposal.
2. When did the board decide to write off the Z10 inventory?
3. How many units does this write off include and to what price were they written off to? Also how many units remain in channel inventory versus in BlackBerry inventory?
4. When did the board become aware of Mr. Watsa’s take-under bid? I will refer to this as a take-under bid, as prior to the announcements listed above, the share price as materially above the $9.00 per share bid price.
5. Were any of these releases made with an eye to reducing share price in order to make Mr. Watsa’s bid more palatable to shareholders? If the board was unaware of Mr. Watsa’s intention to bid for the company at $9 per share prior to pre-announcing the bad news, why was that particular date and time (September 20th after 3pm) chosen? Optically it was a bad time to release bad news as Mr. Heins had sold shares (11,494 @ $10.5366), at a materially higher price, earlier in the day as part of his automatic share sale plan.
6. If the board was aware of materially bad news or the take-under, do you feel ethically responsible in suspending C-level automatic share sale plans? It is not the amount of money involved in these plans, just the principle of the CEO selling shares hours before releasing news that would definitely send the share price lower.
7. Why was no earnings conference call held after the most recent results? Due to the significant changes in accounting for sales, the large write-down of inventory, and the close nature of Mr. Watsa’s relationship with BlackBerry, a call could have allowed investors an opportunity to better understand the situation. Most specifically, it is very difficult for analysts to value the company or know the sales trajectory of the BB10 products when they are unable to ask questions about the recent significant changes.
8. Do you feel it is a conflict of interest that Mr. Watsa was involved on the compensation committee that increased Mr. Heins payout in the event of a take-over (regardless of price), just months before he placed a bid? It should also be noted that the enterprise value of the bid is just $2.4 billion dollars, an amount that represents just 150% of revenue in even this most disappointing recent quarter (even after the accounting changes).
9. Why has no one fallen on the sword, especially considering the mass layoffs? Given the over-abundance of evidence that several things involved with the Z10 (in particular) were unmitigated disasters, why has no one fallen on the sword or been terminated? Specifically, those that championed the Z10 introduction over the Q10 were directly responsible for a $1 billion write off. The marketing campaign was also universally derided, at the minimum that should mean a new Chief Marketing Officer.
Here is my final, and most important question: given all of the above information and questionable decision making made by senior management and the board of directors of this company, in just the past 18 months, do you feel that the board of directors is adequately positioned to provide advice to shareholders on accepting this offer? It appears that the board reviewed and accepted the offer in a matter of hours (the share price didn’t drop below $9.00 per share until Friday September 20th, and by Monday September 23rd the board had reviewed and approved Mr. Watsa’s offer). The decision to make the Z10 the flagship product should automatically disqualify anyone (who voted to make it the flagship product) from the board of directors, or senior management, from being employed at BlackBerry let alone participating in any future strategic planning discussions.
As an aside: please do not make the same mistake with the Z30 that you did with the Z10. If it’s at the point that it’s finished, you might as well release it. Just don’t build millions of them. They aren’t going to sell well… and even if by some miracle they do, then build more then. In a future article I will outline some ideas that could help turn the company around, as I hate always being so negative.