Taking BlackBerry Private Makes No Sense

| About: BlackBerry Ltd. (BBRY)

On August 12, 2013, BlackBerry (NASDAQ:BBRY) issued a statement that its board of directors had formed a special committee to evaluate strategic alternatives. BlackBerry listed possible strategic alternatives as joint ventures, strategic partnerships, and an outright sale of the company. As part of this strategic alternative statement, Prem Watsa, Fairfax Financial Chairman and CEO, announced that he would be stepping down as a member of the BlackBerry board of directors. Prem Watsa, also known as the Warren Buffett of Canada, cited his intent to avoid any potential conflict of interest as basis for his decision to resign. Fairfax Financial owns roughly 10% of BlackBerry as the company's largest shareholder.

On September 9, 2013, BlackBerry stock tacked on 69 cents above $10.84 to close out the trading session at $11.53 per share. That day, speculators helped drive BlackBerry shares towards a 6.4% gain upon rumors that Prem Watsa was working to assemble a consortium of private equity and pension investors willing to purchase the telecommunications company. The following day, on September 10, 2013, sources close to The Globe and Mail reported that "none of the big funds have jumped on board with the idea" to take BlackBerry private. Globe and Mail also intimated that Fairfax Financial began shopping around its BlackBerry stake to test the market for interested buyers. BlackBerry stock got whipsawed and immediately gave back its prior day gains to close out the September 10, 2013 session at $10.94. Speculators in BlackBerry should conclude that proposed deals to take the company private near current valuations make little to no economic sense. In actuality, BlackBerry stock is a strong sell.

BlackBerry at Waterloo

In retrospect, a 2008 photograph of President Barack Obama and his trusted BlackBerry marked the apex of this specific wing of the smart phone movement. BlackBerry was then the leading handset, as it served roughly 50% of the smart phone market through 2008. At the time, the BlackBerry phone emerged as a status symbol for high powered IT professionals, government officials, and business executives. On June 19, 2008, the then Research in Motion stock established an all-time high at $148.13 per share, or approximately $85 billion in market capitalization. The prior year, in 2007, Apple was to have launched its revolutionary iPhone handset. The eventual success of the Apple (NASDAQ:AAPL) iOS ecosystem drove market leadership away from serious technocrats and more so towards fun-loving hipsters.

A scathing 2012 piece written by Jessie Hicks for The Verge thoroughly documented the inevitable downfall of the BlackBerry Empire. Ironically, Hicks depicted a corporation that was ultimately felled by its own arrogance at Waterloo. Within his article, Hicks ripped BlackBerry as a "provincial fiefdom." The 2011 and 2012 years were marred by hostile press conferences, product launch stampedes in Jakarta, and the arrests of BlackBerry executives on plane transit for "mischief." Research in Motion was to ultimately change its name to BlackBerry, promote Thorstein Heins as CEO, and launch the BlackBerry 10 operating system. All turnaround efforts, however, have largely failed to ignite growth at BlackBerry.

BlackBerry speculators hoping for a private equity deal may not recognize the depths to which this company has fallen. On August 7, 2013, research firm comScore released its report summarizing June 2013 U.S. smartphone subscriber market share. The report presented averages of data compiled from the calendar quarter between April 2013 and June 2013. According to comScore, the Google (NASDAQ:GOOG) Android - Apple iOS operating system duopoly drove 91.9% of U.S. smart phone subscriptions through Q2 2013. At the same time, Apple and Samsung were a respective one and two atop the leader board of smart phone original equipment manufacturers. Meanwhile, the BlackBerry operating system actually lost 0.8% in share to carry a meager 4.4% of the smart phone market. International Data Corporation (IDC) information also reported that the company shipped 100,000 BlackBerry operating system tablets through calendar Q2 2013. For the sake of comparison, IDC estimated that Android operated 28.2 million tablet shipments during this same second calendar quarter.

The Private Equity Business Model

Private equity firms may leverage relatively large amounts of debt to purchase struggling corporations. Taking a business private effectively grants management leeway to make decisions away from the pressure of Wall Street and quarterly earnings expectations. Private equity management teams typically refinance debt, terminate employees, and liquidate underperforming assets, in order to improve cash flow. At a later date, the private equity firm may sell off the leaner and more productive enterprise at a significant profit. In most cases, the private equity firm profits through restructuring and financial engineering, rather than any real transformation of the acquired business operation. The majority of private equity firms would lack both the technical know how and the capital to entertain any proposals for taking over BlackBerry.

BlackBerry closed out its latest September 13, 2013 trading session at $10.28 per share, or roughly $5.5 billion worth of market capitalization. In effect, BlackBerry management decisions have destroyed nearly $80 billion worth of shareholder value over the past five years. Private equity firms must therefore be willing to pay a significant premium above current BlackBerry market levels, in order to sidestep lawsuits from angry shareholders threatening to derail a takeover bid. Most likely, BlackBerry shareholders will accept no less than $7.25 billion as compensation for their corporation. An aggressively leveraged buy out deal may add $5 billion in debt to the private company. Management would then be forced to dip into $2.8 billion in cash and short-term investments now listed as BlackBerry assets to meet these credit obligations. For its latest Q1 2014 ended June 1, 2013, BlackBerry added only $170 million in cash and short-term investments to its balance sheet. Going forward, cash flow from operations may deteriorate further, because BlackBerry must amp the research and development and selling, marketing, and administration ante to compete against the likes of the Google Android - Apple iOS duopoly.

Private equity wheelers and dealers must also weigh in upon the idea that running partners Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC) have signaled their commitment to muscle into the mobile space. On September 3, 2013, Microsoft announced that it would be purchasing Nokia's (NYSE:NOK) handset and device business for $7.2 billion. Alternatively, Intel has aggressively put cash into research and development to build out its mobile chip presence. Intel increased R&D spending to $10.1 billion through 2012 from $8.4 billion in 2011, although revenue at the company declined slightly from $54 billion to $53.3 during the past twenty-four months. On average, Microsoft and Intel have generated $46 billion in combined annual cash flow from operations over the past three years. Microsoft and Intel obviously maintain the financial firepower to establish Windows as the third wheel mobile operating system behind iOS and Android. BlackBerry is literally the odd man out.

The Bottom Line

Again, BlackBerry closed out its latest first quarter of fiscal 2014 with $2.8 billion in cash and short-term investments on the books. $5.5 billion worth of BlackBerry market capitalization may be described as a "value trap" where the stock appears nominally cheap, while in actuality, the real value of the underlying business is all but worthless. The BlackBerry balance sheet does include $3 billion in accounts payable and accrued liabilities that effectively cancel out the aforementioned $2.8 billion in liquid assets.

BlackBerry racked up $84 million in Q1 2014 losses. In theory, all real and intangible assets that cannot be leveraged for a profit will depreciate towards zero. Last quarter, BlackBerry listed $887 million in inventories, $2.2 billion in property, plant, and equipment, and $3.5 billion as intangible assets. Any private equity firm kicking the tires at BlackBerry faces the prospects of writing down significant amounts of $6.6 billion in assets. An immediate $1.5 billion charge would leave private equity buyers with $11.5 billion in assets above $3.4 billion in liabilities, after shifting $346 in deferred revenue to net income. BlackBerry would then deliver $8.1 billion in book value, in exchange for the aforementioned buyout price of $7.25 billion. At these levels, BlackBerry is far from a private equity bargain, especially as the business continues to deteriorate sharply. In this case, Main Street investors should also take their cues from Wall Street and walk away. Over the long term, Intel, Nokia, and Microsoft Windows synergies will shut BlackBerry out of the mobile market. At a later date, creditors can pick up BlackBerry assets on the cheap through bankruptcy litigation. For now, BlackBerry stock is a strong sell.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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