Ouch. BlackBerry Ltd. (TSX:BB)(NASDAQ:BB) shares are now down 26% from 52-week highs thanks in part to an underwhelming Q1 fiscal 2019 quarterly report that adopted new accounting rules (ASC 606) for its Enterprise Software and Services (ESS) business.
For the first quarter, ESS revenues plunged 18% year over year, which is a lot uglier with the new accounting standards. Under the old rules, ESS would have just fallen by 11% on a year-over-year basis, so to many investors, the quarter appeared a lot uglier on the surface that it actually was.
The new accounting rules are expected to be a better representation of recurring revenues as BlackBerry cuts out perpetual licenses from its offerings, instead opting to go the route of a subscription-based model.
Gravitation to recurring revenue streams from subscription-based models has become a significant trend among software providers over the last few years, so BlackBerry’s transition shouldn’t come as a surprise, as most other software firms (and consumers) have already embraced the subscription-based approach. For BlackBerry, I think the change was the right move over the long haul even though investors weren’t fans of the change.
A subscription model requires that software service providers deliver more value for its subscribers on a consistent basis to retain recurring revenue streams, however. So, in the near-term, BlackBerry, like all other firms transitioning to a subscription-based approach will likely face immense skepticism on the value clients will stand to receive from a subscription-based model, which is costlier for them over the long haul.
Who knows? The subscription-based approach may work out for the better as it has for Adobe Systems Incorporated. Should this happen, BlackBerry’s gross margins could receive a nice boost (above 75%) as it moves deeper into the business of enterprise software.
Foolish takeaway
I think the post-earnings flop was overblown and would argue that the transition to a subscription-based approach will be the right move in retrospect. Although BlackBerry faces fierce competition on the enterprise software front, I think investors would be wise not to discount the potential of BlackBerry given the impressive technologies that have emerged with CEO John Chen at the helm.
BlackBerry has developed a reputation for producing some of the most secure platforms available in the market. When cybersecurity breaches have become the norm, I suspect the transition to a subscription-based model may be more enticing to prospective clients who desire a higher quality of service through more frequent updates.
I think BlackBerry has a relatively large margin of safety after the most recent plunge and I encourage long-term growth investors to scale into a position today before the stock takes off.
Stay hungry. Stay Foolish.
