On September 23, 2013, BlackBerry (BBRY) announced an all-cash bid for the company at $9.00 per share from Fairfax Financial (FFH). BBRY stock, which had slumped to $8 and change before the bid promptly rallied back up to the bid price. Since then, the share price has drifted back down to close to $8, giving arbitragers a highly unusual 12% plus spread to the bid price. Such a wide spread is indicative of a market that places considerable doubt on the transaction concluding. Just what is wrong with the Fairfax bid?
First, it needs to be understood that this is not a takeover of BlackBerry by Fairfax, as many investors think. Fairfax is presently BBRY's largest shareholder with a 10% stake. Their bid will not see Fairfax increase their stake. Instead, Fairfax will attempt to put together a consortium of investors to take up the other 90% of the stock.
Second, the Fairfax bid is not a firm bid; it is subject to financing and subject to due diligence.
Third, the Fairfax bid costs Fairfax nothing but can provide hundreds of millions of dollars to Fairfax if Fairfax is outbid by a third party. This is because the Letter of Intent that Fairfax has entered into with BlackBerry contains at least three provisions to provide Fairfax with substantial payments under certain circumstances. Specifically, the following fees would become due and payable to Fairfax:
- A "break fee" of $0.30 per share is payable to Fairfax if a superior bid is accepted by BBRY or if BBRY terminates good faith negotiations with Fairfax. This fee would amount to over $150 million, based upon the current number of BBRY shares outstanding.
- If definitive purchase and sale documents are signed between Fairfax and BBRY and BBRY breaks the deal, then the break fee rises to $0.50 per share, or over $250 million.
- Fairfax will receive up to $5 million from BBRY to cover its out of pocket deal expenses if BBRY was to not go forward with the Fairfax deal.
Given that at the current BBRY share price of $8 the Fairfax stake is worth roughly $400 million, these are not unsubstantial fees. The break fees represent a 37% - 62% return on the current value of the Fairfax holding.
There is an enormous difference in the value of a topping bid to Fairfax than to all other shareholders. Let's suppose that another bidder does come forward. Given the $0.30 break fee, they would have to probably pay at least $9.50 per BBRY share to knock Fairfax out. That would improve the other BBRY shareholders investment by about 5.5% ($0.50/$9.00 =5.555%). But in that case, Fairfax would receive the additional $0.50 per share on its 50 million shares plus the break fee of $150 million plus the deal expenses of $5 million, for a total return of $180 million. Fairfax investment in BBRY just increased by 45%.
The real problem with the Fairfax bid is that it is not a real bid at all. At best it is a stalking horse bid, designed to hopefully sniff out other bidders who could top the Fairfax bid and in the process make a massive return for Fairfax while the average shareholder is made only slightly better off. This cozy inside deal smacks of cronyism and provides massive upside for Fairfax with minimal downside, while doing relatively little for the rest of the BBRY shareholders. The BBRY Board knew how weak their negotiating position was and that is why they gave Fairfax such generous terms in their stalking horse bid. The market is heavily discounting Fairfax' chances of success, and it seems that by the terms of their Letter of Intent, the BlackBerry Board is too. Investors seduced by the 12% spread need to proceed with extreme caution, as Fairfax has ancillary motivations to put forward their "bid".