My article yesterday about BlackBerry (NASDAQ:BBRY) titled "Fairfax Financial's Debt Investment In BlackBerry Could Wipe Out Shareholders" sparked a lot of debate with questions and issues raised in the comments section. I decided to write a follow up article to answer some of these questions.
Issue #1 and #2: There are many interested bidders for BlackBerry, including Cerberus Capital, and to compare BlackBerry to the Yellow Pages business is ludicrous.
My interest was piqued as soon as I heard that BlackBerry founders were talking to Cerberus about a bid for the company. It was a trip down memory lane for me and somewhat ironic given that some BlackBerry longs found my comparison to the Yellow Pages business to be unreasonable. My article titled "AT&T Dumps Yellow Pages Business: What This Means For Yellow Pages In Canada" talks about Cerberus Capital Management buying AT&T's (NYSE:T) Yellow Pages business last year.
Cerberus has a focus of investing in distressed assets, and I wouldn't think a bid from a vulture investment firm would exactly spark investor excitement. Referring to my article you can see that Cerberus paid a 1.74 EBITDA multiple for the Yellow Pages business and many people felt that they overpaid.
No matter how much BBRY supporters believe that the stock is undervalued, the facts will tell you otherwise. Despite the fact that BBRY's stock price has tanked over the last several years the company is still not trading at a level which could be referred to as distressed or at a bargain. According to Yahoo Finance, BBRY has an Enterprise Value to EBITDA (EV/EBITDA) metric of 6.5 at a stock price of $6.51 as its $1.01B enterprise value is met with $156M of EBITDA, which most people will agree is headed south at least in the short term.
When we talk about Cerberus buying out BBRY and we refer to the price they paid for AT&T's Yellow Pages business, it does not leave a lot of hope for the bullish side. A 1.74 EBITDA multiple is a far cry from the 6.5 multiple someone would have to pay to buy out BBRY at Thursday's closing price. For Cerberus to be a serious bidder for BBRY, the stock price has to drop A LOT further from $6.50.
As far as the Yellow Pages comparison being ludicrous, in some ways I agree because the BlackBerry business is actually worse in its current state. I think most objective people will agree that from a brand perspective and consumer perception, BlackBerry smartphones and the Yellow Pages advertising print book are seen as relics of the past and are "uncool" or "inferior" today, with the difference being that the Yellow Pages business had a few decades longer of a successful run. In that sense they are equivalent.
But referring again to my Yellow Pages article, at the time of the purchase AT&T's Yellow Pages business had a year-over-year decline in revenue of 16% with a 31% EBITDA margin. Canada's Yellow Pages, now referred to as Yellow Media (OTC:YLWDF), at the time had a 51% EBITDA margin on a year-over-year decline in revenue of 5% (since then the revenue decline has increased before becoming stable). Referring to BBRY's disastrous financials from August, we see that revenue declined from $2,861M in the same period in 2012 to $1,573M in 2013 for a 45% decline. EBITDA margin is greatly skewed to the negative thanks to the large write-off they took during the quarter, but the adjusted loss from continuing operations was $248M and it excludes the $1B charge. Adding back depreciation of $171M to this amount leads to an EBITDA of -$77M or -5%. Although the comparison is for just one quarter, most people agree that in the foreseeable future BBRY will achieve similar poor operating results in its business. When we compare everything objectively by the numbers, the Yellow Pages business are vastly superior to BlackBerry in terms of EBITDA margin and slower revenue decline. So if comparing the businesses are ludicrous, I would suggest the ludicrous aspect of it sides with BlackBerry.
Even if you don't like the Yellow Pages comparison, there are a bunch tech firms out there which have been much more successful as of late than BBRY which trade at a EV/EBITDA multiple equivalent or lower than BBRY. Symantec Corporation (NASDAQ:SYMC) trades at an EV/EBITDA multiple of 7.4 at a stock price of $22.83. Cisco Systems (NASDAQ:CSCO) trades at an EV/EBITDA multiple of 6.5 at a stock price of $23.11. Hewlett-Packard Company (NYSE:HPQ) trades at an EV/EBITDA multiple of 4.5 at a stock price of $25.69. Microsoft Corporation (NASDAQ:MSFT) trades at an EV/EBITDA multiple of 7.4 at a stock price of $37.50.
BlackBerry supporters often talk about the value in the company's patents. Well, Wi-Lan Inc. (NASDAQ:WILN), a company known for its hoarding of patents, trades at an EV/EBITDA multiple of 4.6 at a stock price of $3.18. Finally, BBRY's former arch-rival Apple (NASDAQ:AAPL) trades at an EV/EBITDA multiple of 8 at a stock price of $512.49. It is scary to see how expensive BBRY is compared to its peers given that they are all in a revenue growth or stabilization stage and BBRY is in steep decline.
Investors bullish on BlackBerry would have very little evidence supported by facts and numbers that would support their case that the stock is cheap. What they often go on is the fact that the stock price has tanked a lot, Prem Watsa appears to love the business (just like he loved the newspaper businesses) and there is some vague value attached to BBRY's patents that implies the possibility of a buyout at an ever lower price as time goes on.
Issue #3: I, or other bears claim that the business is worthless.
I never said that the business is worthless. I said that the stock has a good chance of becoming worthless as there is now debt on the books which outrank the shareholders. There is a big difference. Let's take the Cerberus Yellow Pages example. If BBRY were to be valued at an EV/EBITDA multiple of 1.75 just like Yellow Pages in a liquidation scenario in three years and all cash was exhausted, assuming that EBITDA remains at around $150M, BBRY's enterprise value would be around $270M. Shareholders would be wiped out and even the debtholders only get 27 cents on the dollar. But the business would not be worthless. Just the shares.
Let's use a much kinder example. Assuming in three years BBRY has $1B left in cash, an EBITDA of $200M and is valued with an EBITDA multiple of 5. The total purchase value would be $2 billion - one each for the cash and the business. The debtholders would be paid first which would leave $1B for the 514M shares outstanding, or less than $2 per share and that doesn't factor in the share dilution that will take place for bringing in John Chen or the $250M break fee (more on those pieces next).
Issue #4: John Chen will be the savior of Blackberry
From what I have read, John Chen appears to be a perfectly capable leader. He may be able turn the business around. But I have several issues with his hiring. First off, his compensation package is ridiculously high, especially considering he has the word interim attached to his position. The good news for BBRY shareholders is that his annual salary is a reasonable $1M a year. But with bonuses and stock incentives his total compensation could exceed $85M. Put it in this perspective - one of Muddy Waters claims against NQ mobile (NYSE:NQ) was that Omar Khan was fronting for the company and was overpaid to do so with nearly $100M in stock incentives. John Chen will be compensated nearly as much.
In my blog I called out Farifax's bid on BBRY as a ploy to exit its position or slow the bleed on BBRY's stock price. We know the company has a history of making headlines just to get the attention off of BBRY's horrible financial performance. I believe the hiring of John Chen is just another ploy to slow the eventual tank of the stock price as it gives some investors hope of a turnaround. The overpayment in terms of stock incentives and the interim moniker attached to him as BlackBerry's new chief suggests that it took a lot of arm twisting for him to be convinced to take the position and that he is very cautious and non-committal about it.
Who would offer someone a job that pays out $85M in total compensation and structure that compensation to ensure they stay at least 5 years yet demand that they be termed the "interim CEO"? That makes no sense. The demand to be referred to as an interim leader very likely came from John Chen himself and that is to provide himself with an easy escape to keep his reputation intact in case he thinks that BBRY is in too deep of a mess to be saved.
Issue #5: BBRY has $4B, $5B or whatever much higher amount of cash than my claim and I am being far too pessimistic about BBRY's cash position.
No, they don't. If an investor is to talk about BBRY's cash, they MUST talk about net cash. There are $3B of liabilities that must be settled in cash in the near future. The $1B cash influx from the debenture has an offsetting liability associated with it, and has a coupon payment of $60M a year in addition to the operating losses that the company will experience in the coming quarters. It is NOT a gain in net cash, really it's more of a tool for Fairfax and associates to extract whatever value that they can from the company. As far as the $1B in tax refunds - until that is on a balance sheet as a reasonably collectible asset, that asset is speculative.
Issue #6: Fairfax is not investing in 100% of the debenture, and my conspiracy theory that they are going to take under company makes no financial sense to them.
I always referred to the deal as Fairfax and associates. I was well aware that Fairfax alone wasn't the only investor. As far as the math and logic behind it - anyone who follows mining companies on the TSX knows a lot of large investors have lost a lot on paper in their equity stake. Many of them will know that a popular way to recoup those losses is to let the company go under, then purchase its assets in a CCAA proceeding. Retail investors don't think the same way as large investors. Retail investors buy shares in a stock. Large investors buy businesses and/or assets. They are relatively indifferent whether that is through a buyout or minority purchase on the equity market or through a bankruptcy sale. My article from yesterday shows that Fairfax has a propensity to buy up distressed debt in order to gain an equity stake in the restructured company. In a restructuring the assets are often unchanged - it's only the corporate structure and financing that is different.
Regarding the math itself - Fairfax owns a 10% stake in BBRY. A situation in which shareholders are completely wiped out and debtholders get 100% of the equity in a newly restructured company, Fairfax would see their equity stake rise to 25% as that is the portion of the bonds they are invested in. They win. Retail investors mistakenly think because Fairfax will take a big loss on the shares that the company would never allow this scenario to happen. In reality, a wipeout of its BBRY equity stake and restructuring would provide Fairfax with some nice tax loss credits along with an increased stake in BBRY assets. Fairfax has as much incentive to see equity shareholders get wiped out as they do to see BBRY turn it around. This along with the $250M break fee was a brilliant set up by the company so that it makes money no matter what happens to BlackBerry, all on the backs of minority shareholders.
Issue #7: I am just a shorter and I want the company to fail/personal attacks on me.
I do not *want* BlackBerry to fail any more than any other company out there. BlackBerry IS failing and all I'm doing is calling it out on its failure. There are thousands of investing options for me to choose from and out of the few I decide to take, a BBRY short position through put options is one of them. I have shown in my last two articles that BBRY has a much worse cash position than what many people believe, its burn rate is high, when comparing to its tech peers it is not cheap, its business is on a similar path to Yellow Media which dropped in stock price from well over $5 to a few pennies in less than two years, its most vocal bullish significant shareholder has a history of investing in distressed assets in which the equity went to zero, and the company has extremely weak corporate governance where Fairfax has managed to set up a situation where it makes money whether or not the company survives under the BBRY symbol and where it has to pay an enormous compensation package to an interim CEO. What is there not to like about shorting this company?
Disclosure: I am short BBRY. 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. I am short through put options