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There has been a lot of skepticism about the chances that Prem Watsa's bid for BlackBerry (NASDAQ:BBRY) will go through. Many people believe that Watsa is playing bluff poker to put BlackBerry in play and protect his stake while leaving the door open for him to withdraw the bid with no penalty. We do agree that there is a distinct chance that this is the case, but are also proposing that this is an ideal time for Watsa to make a bid if he is truly interested in taking BlackBerry private. As well, given the typically low success rates in finding additional bidders under go-shop clauses, it seems likely that Watsa is serious about the offer, even if financing remains a major question mark.

Reducing Bidding Competition

One reason the timing seems ideal right now for Prem Watsa/Fairfax Financial to make a move on BlackBerry is that competing bidding interest would be low right now. BlackBerry just announced a terrible earnings warning and there are limited catalysts that would provide some hope about the future outlook of the company before the November 4th go-shop end date. One of those potential catalysts is the BBM rollout to iOS and Android. A strong reception to that would boost the value of BlackBerry and likely increase interest in BlackBerry at $9 per share or above. However, the BBM roll-out to iOS and Android has been pushed back "significantly" without any concrete timeline for release at this point. BBM release could occur next week, or it could occur much later than that.

As well, the major price decrease that should accompany the massive write-off of Z10 inventory will not be apparent in sell-through results for some time yet. Other potential acquirers will not know yet whether there is significant interest in BlackBerry 10 as a platform if inexpensive phones are available for it. The perception right now is that BlackBerry 10 is a flop, but the effect of pricing has yet to be determined.

Any other parties that are interested in BlackBerry will probably want some positive signs such as BBM uptake or improved sales at lower prices before making a bid. Hence by making a bid right now, Watsa can drive away other potential bidders that are unwilling to take a leap of faith and spend time negotiating before there is any positive news.

As well, another factor complicating bidding competition is Canada's right to review foreign takeovers of Canadian businesses. Prem Watsa's bid has a high probability of regulatory approval, while non-Canadian bids would face additional scrutiny.

Needing To Act Quickly

Another reason Prem Watsa may want to make a bid right now is that BlackBerry's future prospects are declining rather quickly. The poor results and the ongoing uncertainty about its future (such whether it will be sold or shutdown its hardware division) are helping to send BlackBerry into a downward spiral. Enterprise customers in particular would want to be confident that BlackBerry is still around and committed to its platform in several years. These delayed or cancelled purchases makes BlackBerry's results worse and thus further reduces confidence in BlackBerry.

Prem Watsa could have waited for BlackBerry to drift lower before making a bid. Aside from other potential bids, there is likely no news in the short term that would push BlackBerry's price significantly higher. However, the longer he waits, the harder it will be to turnaround BlackBerry. Waiting a few months may have potentially reduced the bid price by $500 million to $1 billion, but the damage to BlackBerry's future prospects may be more than $1 billion over that time. If he is comfortable due to his strong knowledge of BlackBerry that BBM has mass appeal and/or that BlackBerry 10 can be salvaged, then it makes sense to make a bid sooner rather than later, to help remove some of the uncertainty that is harming BlackBerry's business.

The Go-Shop Process and Termination Fees

As noted in a New York Times article, the go-shop process is typically unsuccessful in attracting additional bidders. Since 2004, 93% of deals with go-shop provisions have failed to attract competing bidders. The article mentions that this is usually because the initial bidder usually has a massive head start. In this case, Prem Watsa has apparently been interested in taking BlackBerry private for a while, and is certainly well acquainted with BlackBerry.

The six week go-shop period is quite typical, with one study mentioning an average of 53 days and a median of 42 days for go-shop periods. The termination fee of $0.30 per share is around average as well at 3.3% of the transaction value compared to the average and median of 3.5% for transactions in 2012.
The length of the go-shop period and the termination fee size with BlackBerry doesn't seem abnormal in terms of attracting or deterring additional bidders.

BlackBerry: A Value Play

In a previous article, we noted the valuation ranges that various Wall Street analysts had put on BlackBerry's parts. After updating that valuation for the decrease in cash and investments to $2.6 billion and assuming that the valuation of all the other parts are at the low end of their ranges, we end up with a value of $10.68 per share. Watsa's bid represents a 16% discount to that value, which means that BlackBerry at $9 per share is a good opportunity for a value investor like him, assuming that he agrees with the Wall Street analysts about the valuations of BlackBerry's parts.

Valuation

Low

Services and Software

$3.0 Billion

Patents

$2.0 Billion

Cash and Investments

$2.6 Billion

Hardware

($2.0 Billion)

Total

$5.6 Billion

Shares Outstanding

524.16 Million

Per Share

$10.68

Eliminating Shareholder Resistance

At this point, many BlackBerry shareholders are beaten down by the stream of negative news. Shareholders are also getting a picture of what could happen to BlackBerry's price if the bid fails, which would be to drive the price significantly below $8. That is likely much lower than the price would have been if Watsa's bid had not been made in the first place. A failed bid by Watsa would take the most likely suitor off the table, and force shareholders to contemplate waiting out a long restructuring process instead. By making a bid at an optimal time to avoid any competing interest, Watsa could negate shareholder resistance to a deal.

Normally a bid at a limited premium and at prices below what most shareholders paid would encounter significant resistance. However, Watsa could be playing a different bluff - daring shareholders to test whether he will propose a higher bid or walk away (and perhaps liquidate his holdings) instead. The news about the lack of concrete financing probably helps the chances that his bid will be accepted by shareholders (if he does get financing) since the share price has been quite unstable as a result.

Why Prem Watsa Intends To Follow Through With His Bid

Another way to look at this would be to look at the estimated value of Prem Watsa's shares under different scenarios. If he didn't make an offer, he may have been able to quietly liquidate Fairfax's position between October and February 14, 2014, which is when he would have needed to submit an update on Fairfax's holdings as of the end of the fourth calendar quarter. While 51.9 million shares is a lot to dispose of, it probably is possible to sell 500,000 to 600,000 shares per day without massive effect when BlackBerry averages volumes of around 30 million shares per day. We are going to assume that he would get an average of $7.50 per share if he hadn't made an offer, netting him around $389.25 million from disposing his stake.

Scenario

Shares (Million)

Average Price ($)

Value ($ Million)

Without Fairfax Bid

51.9

$7.50

$389.25

On the other hand, if there is no alternative offer and Fairfax withdraws its bid, we are going to assume that Watsa is only able to get $6.50 for his shares as BlackBerry's value is no longer propped up by the possibility of acquisition. However, if there is an alternative offer, we assume that Watsa would receive $9.20 per share + $0.30 per share in termination fees.

Scenario

Percent Chance

Shares (Million)

Average Price ($)

Value ($ Million)

No Alternative Offer

66.7%

51.9

$6.50

$337.35

Alternative Offer

33.3%

51.9

$9.50

$493.05

Total

$389.20

After doing the math, there would need to be a 33.3% chance of an alternative offer being made for Watsa to break even in this scenario versus the scenario where he did not make a bid in the first place. As mentioned before, transactions with go-shop provisions have averaged a 7% chance of attracting competing bidders before. The length of the go-shop period and termination fee in this case is around average as well, although the premium for BlackBerry's shares is below average, which may make attracting competing bidders easier. We would estimate the chances of an additional bidder at 20% based on the smaller than average premium, which would still make it more advantageous for Watsa to have not made the offer in the first place unless he intended to follow through with it.

Conclusion

While there is a reasonable chance that Prem Watsa is using his offer as a way to protect his stake and get additional bidders into play for BlackBerry, we feel that it is more likely that he is serious about taking BlackBerry private and that the main risk is with securing financing. The timing of the bid seems ideal in deterring bidding competition and reducing shareholder resistance while also preserving the chance that BlackBerry has a future. The go-shop process has typically been unsuccessful in attracting additional bidders as well, and with a 20% chance that an additional bidder will emerge, it seems that Watsa would have been better off quietly liquidating his stake than making an offer that he didn't intend on following through with.

As for the effect on shareholders, it appears that there will likely be a tough choice between taking a $9 per share offer or attempting to wait out a restructuring period that will last over a year. In a future article we will attempt to examine how much a smaller BlackBerry may be worth if it succeeds. Inability to close financing also remains a significant and unpredictable risk and should also be factored into any decisions on BlackBerry, which is quite a speculative play at this point.

Source: BlackBerry: Is Prem Watsa Really Interested In Taking It Private?