On November 4, 2013, BlackBerry (BBRY) issued a press release that it had concluded its strategic review. Instead of selling off the company, BlackBerry took on a $1 billion loan from a consortium led by Fairfax Financial (OTCQB:FRFHF). Terms of the deal called for the Fairfax Financial group to receive a 6% interest rate upon the $1 principal amount that may also be convertible into BlackBerry stock at $10 per share.
As somewhat of an adjunct to this convertible bond agreement, BlackBerry moved to replace current CEO Thorsten Heins with John S. Chen, while also appointing Fairfax Chairman Prem Watsa to lead director. Wall Street was clearly not pleased with this chain of events, as traders immediately dumped BlackBerry stock to $6.50, which marked a 15% loss for the November 4 session. At these levels, the BlackBerry handset and services businesses are effectively worthless. Prospective investors may also opt to pass upon mining for value within the BlackBerry patent portfolio. The $1 billion convertible bond has shoved shareholders even further to the back of the BlackBerry line.
Fairfax Buyout Offer Falls Apart
On August 12, 2013, BlackBerry announced that it had formed a Special Committee to explore strategic alternatives for this company. Upon this press release, Fairfax Financial Chairman Prem Watsa also announced that he would be stepping down from the Board of Directors, in order to avoid any potential conflicts of interest. Fairfax Financial then owned 9.9% of outstanding BlackBerry stock, as the company's most powerful shareholder. One month later, on September 23, 2013, BlackBerry entered into a letter of intent with Fairfax Financial that valued the telecommunications company at $9 per share, or $4.7 billion in market capitalization. The letter of intent granted Fairfax Financial time to perform due diligence until early November, when terms of the proposed buyout deal would solidify further.
Wall Street remained cynical towards any alleged sale of BlackBerry. BlackBerry shares actually declined from $8.75 to $7.77 after the company entered into the letter of intent and into the month of November. During this time frame, BlackBerry executives actually flew to Facebook (FB) headquarters in California to pitch a sale to the social media company. Traders speculated that BlackBerry was operating out of desperation, because Bank of America (BAC) and Fairfax Financial were unable to line up financing to close the deal. The BlackBerry bears, of course, were ultimately to be proven correct.
On November 5, 2013, research firm comScore released a report of September 2013 U.S. smartphone subscriber market share. This title was somewhat misleading, as the report presented averages of data collected between July 2013 and September 2013. BlackBerry actually lost 0.6% in market share through the summer months. BlackBerry systems operated a mere 3.8% of U.S. subscriber smartphones by the end of September 2013. Taken together, Google (GOOG) Android and Apple (AAPL) iOS systems operate a combined 92.4% share of U.S. smartphone subscriptions. Going forward, Microsoft's (MSFT) acquisition of Nokia (NOK) is set to close during Q1 2014. This deal will establish the Windows brand as a third-wheel alternative to the Apple iOS - Google Android duopoly.
BlackBerry Book Value
BlackBerry stock closed out the November 6, 2013 trading session at $6.63 per share, which calculates out to a mere $3.5 billion in market capitalization. At these levels, Wall Street has literally concluded that BlackBerry would be worth more if it were to be immediately sold for scrap, instead of continuing to operate as a going concern. BlackBerry closed out the second quarter of its fiscal 2014 with $12.5 billion in assets above $4.1 billion in liabilities on the books. BlackBerry executives managed $8.4 billion worth of shareholder equity at the close of business, on August 31, 2013.
At this point, the balance sheet should be broken down, in terms of liquidity. The Q2 2014 balance sheet listed $2.3 billion in cash and short-term investments above the aforementioned $4 billion in liabilities. Within this $4 billion amount, BlackBerry has itemized $202 million in deferred income taxes, $9 million in income taxes payable, and $834 million in deferred revenue. Certainly, tax-loss carry forwards will effectively neutralize this listed tax burden. The $834 million in deferred revenue will also fall off the liability ledger, after these sales are ultimately recognized. $2.3 billion in cash will remain to back $3 billion in accounts payable and accrued liabilities. Be advised that BlackBerry burned through $368 million in cash over the past six months. The short-term investment position did grow by $58 million, after the company pocketed a net $13 million between the proceeds and acquisitions of these investments. BlackBerry also collected upon $610 million worth of receivables between March 2, 2013 and August 31, 2013.
Prospective investors must take the $1 billion convertible bond into account when appraising BlackBerry. This cash infusion is likely to deteriorate towards zero over the next year, while significantly increasing the debt burden on the balance sheet. In the event of any turnaround, Fairfax may convert this block into 100 million additional shares, which would be significant dilution upon the 524.4 million BlackBerry shares now on the books. Traders should rationalize the transaction as more of a short-term play to vault Fairfax Financial to the front of the line as a creditor, instead of a long-term shareholder. Intangibles are the only assets remaining that may carry value, after breaking down the balance sheet and adjusting for cash burn, depreciation, and $1 billion in additional debt.
The Bottom Line
BlackBerry closed out its Q2 2014 books with $3.5 billion worth of intangible assets on the books. Interestingly, BlackBerry finished up Q4 2013 with $3.4 billion in intangible assets and bought $603 million in intangible assets over the next six months. On paper, older patents must be depreciating rather quickly, while roughly 20% of the BlackBerry patent portfolio may be considered relatively new. On May 22, 2012, Google announced that it would be paying $12.5 billion to acquire Motorola. Ironically, a "Rockstar" consortium of Apple, Microsoft, Sony, and Ericsson bought $4.5 billion worth of patents from bankrupt Nortel, prior to that date.
In retrospect, these transactions materialized as defensive moves to guard lucrative smartphone businesses against litigation. Google's Motorola Mobility operating segment may rack up $1 billion in 2014 losses at the search engine company. On October 31, 2013, the Rockstar Group filed a lawsuit to sue Google and Samsung for patent infringement. The bursting of the patent portfolio after a curious move to join ranks with this Rockstar Group has effectively left BlackBerry without a home. Google has quietly sidestepped any talks of acquiring BlackBerry patents, while members of the Rockstar Group cannot be expected to purchase similar technologies from each other.
BlackBerry intangible assets on the books may be written down to $1 billion over the course of the next year. Conservative investors should avoid buying into BlackBerry stock, as the business appears to be a value trap. Wave the white flag of surrender at Waterloo.