One has to wonder why BlackBerry pre-announced its fiscal Q2 results last Friday when its scheduled quarterly announcement is less than a week away. Shareholders got an answer in today's press release when BlackBerry signed a letter of intent with a consortium led by Fairfax Financial. The letter of intent contemplates a transaction in which BlackBerry shareholders would receive US$9.00 in cash for shares not owned by Fairfax (Fairfax owns 10% of the company). This transaction would value the company at US$4.7 billion, a fraction of the value the market gave it back in 2008 when it was worth US$80 billion.
The parties will try to reach a definitive transaction agreement by end of November 4,2013. BlackBerry is allowed to enter into "alternative transactions" with another party during the due diligence period (now till November 4,2013).
It shouldn't be surprising that Fairfax, being the buyer, would offer a low price of US$9. Being a shareholder, I believe this undervalues the company, but I acknowledge the company is facing more headwinds than I anticipated. The low offer price for BlackBerry almost reminds me of Bear Stearns when it was first offered $2 per share on March 14, 2008. Jamie Dimon stated that "buying a house and buying a house on fire is not the same". Ultimately, Dimon had to concede to shareholders by offering $10 per share. In case of BlackBerry, I don't expect the final transaction price to be significantly higher than the current pre-announced US$9 offer price. Nonetheless, it is more likely than not that the final transaction price will be higher than the current US$9. Therefore, I am holding my shares for now especially given the shares are trading below US$9 (BBRY) preliminary offer price. The final transaction may be slightly higher at $9.50-$10.50. The announcement today does buy time for the company to find another buyer as it temporarily puts a floor to the stock price and will limit additional negative rumors on the company. The key point is that Fairfax has provided confidence to BlackBerry 's customers that the company will survive.
Because of today's announcement, the stock has become a special situation and a pure risk arbitrage play. Taking the playbook from Buffett's 1988 annual letter on how to evaluate this situation:
To evaluate arbitrage situations you must answer the four questions:
(1) How likely is it that the promised event will indeed occur? (2) How long will your money be tied up? (3) What chance is there that something still better will transpire - a competing takeover bid, for example? (4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?
The probability of (1) happening is high given Prem's track record of closing deals. Looking at criteria (2), the timing on this arbitrage trade appears to be 6 weeks. As for criteria (3), there is a chance of a better offer from another bidder or another a group of buyers teaming up to buy BlackBerry and carve out the operations. I think there is definitely a chance for a higher offer price than $9.50-10.50 but investors should keep their expectation low for now. Getting a better outcome than expected is never a bad thing! Finally, I think the chances for criteria (4) is less likely given I feel BlackBerry's management has already took the big bath in order to help Prem Watsa. A possible glitch is the financing because the Fairfax group has not finalized the financing yet. Nonetheless, chances are low that Prem cannot find the necessary financing for a $2.1 billion ($4.7 billion less $2.6 cash) bid.
With cash of $2.6 billion, patent value estimated at roughly $2 billion (could be high as $3-4 billion), and value of services/other infrastructure at $1.5 billion, BlackBerry should be worth ~$11.60 conservatively valued. Of course, Fairfax, being the buyer, will not pay that price even if the $11.60/share is a conservative value. However, Fairfax may raise the price slightly to $9.50 or $10 to appease shareholders just like JP Morgan did in its deal with Bear Stearns. There is still value in the company even if they flop the hardware side. The delay in its global BBM launch was disappointing but BBM will still ultimately attract millions of users, which the company can monetize through advertising etc.
The next 6 weeks will be interesting. The earnings report on Friday September 26 will offer more colour on the financial health and future of BlackBerry.