The struggles for wireless communications firm BlackBerry Ltd (Nasdaq: BBRY) have been underway for years.

#-ad_banner-#In early 2013, the company’s business model was showing signs of stress, thanks to surging competition from Apple, Inc. (Nasdaq: AAPL), Samsung, Google, Inc. (Nasdaq: GOOG) and others. Back then, short sellers held nearly 140 million shares, or an estimated 29% of the outstanding share float. As a group, they anticipated a major downdraft ahead.

Fast forward to 2015 and shares have fallen by half. Yet short sellers haven’t booked profits and moved on. They now hold 95 million shares short, or 19.5% of the outstanding share float, making Blackberry the fifth most heavily shorted stock on the Nasdaq. A fresh look at quarterly results reveals why these short sellers still see downside ahead.

Stabilizing The Ship
To be fair, Blackberry’s CEO John Chen inherited quite a mess when he took control of the company in late 2013. Revenues were falling fast, and a high cost structure led to rising losses. Chen is now more than halfway through a two-year restructuring process that is starting to bear fruit. Chen furloughed hundreds of staffers, and annual operating expenses have now dropped by more than $2 billion in the past two years.

Chen understood that the company’s traditional hardware-driven business model was not sustainable over the long-term. He has been pursuing a two-pronged strategy: refresh the legacy phone and tablet computer products to help stabilize hardware revenues for now, while making an accelerated push into software and services.

Trouble is, hardware sales remain in freefall. In the just-completed fiscal fourth quarter, analysts expected more than $400 million in hardware sales, but the company only posted $274 million. A 35% sequential drop in hardware sales was a surprise.

Blackberry launched two new phones in calendar 2014, the Passport and the Classic, and both have seen weak initial demand. Few people now expect Blackberry to come up with phones that will reverse its steady decline in smartphone market share.

That makes the software division a crucial lifeline. Chen thinks that software can produce $600 million in sales for the fiscal year that began in March. Yet Blackberry had just $67 million in Q4 software sales. That slow start suggests that the company will not meet the $150 million quarterly run rate in the next few quarters, and will, therefore, have to greatly exceed $150 million in quarterly software sales later this year. The “back-end loaded” guidance is the simplest explanation for why short sellers are standing their ground.

“We continue to expect that BlackBerry will fall short of this (software sales) target, given a very competitive environment and BlackBerry’s late entry into the market,” note analysts at Goldman Sachs, who maintain a sell rating. To hit his target, Chen has hinted that Blackberry may pursue some acquisitions, but that just underscores the lack of organic momentum for the all-important software segment, on which Chen has pinned considerable hopes.

Another concern: “Services revenues are expected to continue to decline ~15% per quarter throughout 2016, which will more than fully offset any growth in Software,” note analysts at trading firm MKM Partners.

To be sure, Blackberry’s finances are in better shape these days. The company has $3.3 billion in cash ($1.5 billion net of debt, which equates to $3 a share) and Blackberry is now operating much closer to break-even. A $1.14 billion operating loss in fiscal 2014 has shrunk to a $62 million operating loss in fiscal 2015. Equally important, the company is no longer sitting on vast amounts of unsold hardware, and inventory levels are now much leaner than they were 18 months ago.

Yet stable and lean doesn’t mean that Blackberry has made the case for a brighter future. Indeed analysts at Merrill Lynch see shares falling to just $6. They currently trade near $9. “Blackberry’s long-term outlook is unlikely to improve given diminishing strategic options and fierce competitive pressure in consumer and enterprise,” they write, adding that momentum from firms like Apple and Google is just too strong. They expect Blackberry to generate losses in each of the next three years.

Risks To Consider: As an upside risk, the company could look to sell itself to a larger technology or communications firm, though the negative operating momentum may diminish Blackberry’s appeal to potential suitors.

Action To Take –> Consider this to be “Blackberry vs. the shorts: round two.” In the first round, short sellers correctly identified this as a business in trouble. CEO Chen has stabilized a sinking ship, leading shares into a sideways trading pattern, but a further slump in the key sales segments leads short sellers to likely conclude that more downside lies ahead. If you own this stock on hopes of a turnaround, then you may want to re-check your bullish thesis in light of just-released, sobering quarterly results. For investors looking for short sale candidates to hedge their portfolios, Blackberry appears to be an appealing choice.

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