Over the past 10 years, perhaps no company has made worse strategic blunders than BlackBerry (BBRY). Once the dominant smartphone maker, its devices are now barely an afterthought in consumers' minds. However, I do believe the stock has an interesting risk/reward profile in light of potential M&A activity.
For those unaware, Fairfax Financial essentially offered $9 a share for the company. Its offer was more akin to a letter of intent than the hard, tightly worded deals investors look for. In all likelihood, Fairfax is trying to solicit a higher bid to save some face on its 10% stake that has lost the company a significant amount of money. However, trading at $8.20, BBRY shares have 9.75% upside to that $9 offer. Typically, companies that agree to a buyout trade within 2-3% of the deal price. Is the large discount justified?
I begin by trying to estimate what the market deems to be the probability that Fairfax follows through on this bid. Rumors have been floating that the Canadian insurance firm has struggled to find financing for the $4.3 billion it would like to borrow. To estimate the probability in a conservative fashion, I assume that there is 0% probability of a higher offer, so the two possibilities are Fairfax at $9 or liquidation. What would liquidation leave BBRY shareholders with?
As of 8/31/13, BBRY had $12.508 billion in assets, against $4.084 in liabilities, which actually gives the company $16 a share in book value. It is no secret, though, that BlackBerry could not get carrying value for its assets. As such, I decided to mark down its assets. I gave BlackBerry 100% value for its cash, short-term investments, and accounts receivable, which total $4.77 billion. However, for the remaining $7.7 billion in assets (patents, inventory, buildings, etc.), I assumed the company could only get 20 cents on the dollar. Admittedly, it is impossible to know the value of each patent and other assets in an auction scenario, some likely would fetch no offers while others would be closer to full reported value. Additionally, the firm is burning cash, so the longer a liquidation takes, the lower the cash balance. I believe my 20% valuation of other assets more than takes this into account.
Using this method, BlackBerry's intrinsic book value is only $2.24 billion, well below its reported book value of $8.4 billion. At this level, BBRY shareholders would receive $4.35. In my scenario where there are two possible outcomes (Fairfax or liquidation), its current share price reflects an 83% likelihood the deal is completed. While clearly reflecting Fairfax is not a done-deal, an 83% likelihood suggests, contrary to some media reports, the market has some confidence a deal will get done. I had personally felt that the probability of a deal was closer to 67%, meaning BBRY shares would be fairly valued at $7.47.
As such, I had felt BBRY was not a good risk/reward M&A bet. That view changed Thursday when it was learned that BBRY co-founders Mike Lazaridis and Douglas Fregin have acquired an 8% stake and hired Goldman Sachs to explore a bid. The co-founders left BlackBerry prior to the launch of its most recent phone and had been pushing for different strategies, including licensing its security software to other phone manufacturers. These two men see BlackBerry as their legacy and have a plan they believe can turn the company around. Historically, founders of struggling firms are more motivated buyers than other bidders.
I believe it is highly unlikely Lazaridis and Fregin would have their 8% stake and enlist Goldman unless they were serious about making an offer. As of right now, they have not engaged in conversations with Fairfax to make a joint bid, and there is a possibility they decide to bid in excess of the $9 Fairfax offer. If Fairfax truly is struggling to find financing, the co-founders would likely struggle as well. However, should they pool their resources, they would own 18% of the shares, and with this larger equity cushion, financing would much more easily be attained. Fairfax, as an insurer, is unlikely to be interested in making operating decisions and could leave those to the co-founders, acting as a financial sponsor instead.
While I still believe a deal with another company like Cisco (CSCO) or private equity seems slim, simply because BlackBerry has tried to sell itself for months to no avail and the fundamentals have not changed to entice a buyer now, the actions by the founders make me feel far more confident than my original 67% probability of a deal at $9. Either through competing bids or a joint offer, I believe there is now an 85% probability of a deal at $9, a small probability (5%) of a bidding war pushing the price to $10 and a 10% probability of eventual liquidation. Using these probabilities, BBRY shares should be trading at $8.59. If you believe there is a chance that another company decides to buy BBRY, fair value would be a bit higher.
The decision by the BlackBerry founders to put together a buyout offer for BlackBerry is a potential game-changer, making a deal far more likely than when Fairfax was the only interested party. By using a conservative liquidation value of $4.35 as my worst case and a done deal as the optimal outcome, I find that BBRY shares are not fully reflecting the probability of takeover. The shares should be trading at $8.59 rather than $8.20. From a weighted outcome standpoint, BBRY is undervalued and is an attractive arbitrage opportunity.