The cybersecurity company BlackBerry (BB -0.27%) posted a strong revenue growth during its fiscal second-quarter results. But without the contribution from its recent acquisition, Cylance, BlackBerry's revenue would have declined. And management's expectations for Cylance may not match up with reality.
Challenges in a growing market
BlackBerry reported non-GAAP revenue of $261 million during its second-quarter results, up 22% year over year. But this apparently solid growth is due to the extra revenue from its acquisition of the endpoint security company Cylance at the end of February. Excluding this acquisition, revenue would have dropped to $210 million compared to $214 million the year before.
The decline in the company's Internet of Things (IoT) business -- which includes software and services that secure endpoints -- from $141 million to $134 million explains this underperformance. The company's Enterprise Software and Services (ESS) business -- a part of its IoT business -- caused these disappointing results. The company's financial statements don't detail ESS's performance. But the last company's earnings call revealed the ESS business was down in the mid-teens. And John Chen, BlackBerry's CEO, justified ESS's decline with the impact of ESS's salesforce reorganization.
Thus, according to management, the decline in the company's IoT business is temporary. But this deterioration is worrying for three reasons.
First, BlackBerry's IoT revenue, at 51% of its total revenue, represents a significant part of its activities.
Second, revenue declined in the context of a fast-growing IoT market. For instance, IDC, a market research company, forecasted the number of IoT devices to grow at a compound annual growth rate (CAGR) of 28.7% between 2018 and 2025. And BlackBerry's latest presentation highlights 27% average annual growth in its IoT addressable market between 2018 and 2021.
Third, management didn't control the consequences of its sales reorganization. The CEO had mentioned during the quarter before that changes in the sales team were over. And in contrast with the recent ESS's decline, he also said ESS business would post quarter-over-quarter revenue growth for the rest of the year.
Image source: Getty Images.
Cylance's shrinking market share
Besides the difficulties of BlackBerry's IoT business, investors should also pay attention to the performance of the company's endpoint security business, Cylance.
In its latest presentation, BlackBerry's management estimated that the endpoint security addressable market would grow at a CAGR above 30% between 2018 and 2021. And with 24% year-over-year growth during the last quarter, Cylance lost market share. Also, guidance for the full-year revenue growth in the range of 25% to 30% stays below the market's forecasted growth.
Also, Cylance's revenue growth is decelerating at a fast pace. Its revenue growth of 24% during this quarter pales in comparison to its previous quarter revenue growth of 31%. And the midpoint of Cylance's full-year expected revenue growth of 27.5% looks even weaker when compared to its revenue growth of 283% and 90%+ in 2017 and 2018, respectively.
Growing revenue at a constant rate from an expanding revenue base represents a challenge for any company. But Cylance's revenue growth deceleration may signal competitivity issues that could contribute to a further decline. For instance, despite its higher revenue base, Cylance's competitor CrowdStrike grew its revenue at a much higher rate (60%) than Cylance during the previous quarter.
BlackBerry isn't for the prudent investor
Besides its worrying revenue growth deceleration below the expected endpoint security market growth, BlackBerry's Cylance business is facing challenges that management may not have fully considered. For instance, management highlighted Cylance's capabilities in artificial intelligence and machine learning. But this offering isn't unique. Many cybersecurity vendors like Palo Alto Networks, CrowdStrike, Cisco, Fortinet, Check Point, etc. also developed cloud-based endpoint security products based on these technologies.
Besides, most of these companies propose a much broader security and integrated security portfolio that provide cross-selling opportunities BlackBerry can't compete with. For instance, Cisco and Palo Alto offer security devices such as firewalls or gateways.
Thus, investors should not rely on BlackBerry's guidance for an investment decision. Even if you set aside the company's difficulties in its IoT business and the growth deceleration of its Cylance acquisition, BlackBerry reported a GAAP loss of $44 million after another loss of $35 million during the quarter before. The elevated company's selling, marketing, and administration expenses -- at 55% of its revenue during the last quarter -- affect its profitability.
With this context, prudent investors should stay on the sidelines.
