- This is the first of a three-part series on BlackBerry's balance sheet.
- We review the balance sheet impacts of management's plan to return to profitability with an asset restructure and revitalized approach to its customers and markets.
- Our analysis looks at assets both on and off the balance sheet.
Earlier this year BlackBerry (NASDAQ:BBRY) management announced its intention to divest a majority of the company's real estate holdings in Canada. Its headquarters and certain other facilities were to be leased back from the buyer. This was part of a two-step plan to get BlackBerry back on track as a leading supplier of smartphones and communications services. This is the first in a three-part series on BlackBerry's balance sheet and its strategic restructuring.
Most investors are well acquainted with the merits of sale/leaseback arrangements. It is a fast way to convert relatively illiquid assets to cash, which can be substantial even after taxes are paid on capital gains. Indeed, since mortgages are typically limited to 70% to 80% of market value, sellers typically raise more cash in a sale/leaseback maneuver than if the company sought out mortgage financing using the property as collateral. What's more the seller can avoid financing costs and fees that tend to mount up in conventional financing. Leases usually come dressed up with renewal options, which give management teams a longer runway than with mortgage loans that feature no guarantee of refinancing.
BlackBerry investors did not appear much impressed by the sale/leaseback news. Since the announcement the stock has seesawed back and forth a bit, and was trading off by 34% from highs in the first month this year to a low for the current year in mid-April. Of course, other factors are certainly at play in the stock price besides BlackBerry's balance sheet changes. However, its restructuring efforts do not seem to have kindled much investor enthusiasm.
Beyond making a smart move for the sake of cash balances, it is worthwhile asking whether the real estate sale/leaseback is a value-altering event for BlackBerry?
To answer this question, let's first look at how BlackBerry's income, balances and cash flows will be changed by the sale/leaseback arrangement. The majority of the impact is expected to be visible by the end of June 2014. We already appreciate that the balance sheet will have more cash. That means a higher current ratio and increases in all the attendant working capital ratios that shine a light on how easily a company can muster payments for day-to-day operating activities.
Depending upon the classification of the lease, there might be additional changes. A new operating lease will end up buried in a footnote without a trace on the balance sheet. A sale/leaseback arrangement of the magnitude contemplated by BlackBerry ends up making profound changes on the balance sheet under the operating classification. Assets would be significantly lower. On the other hand, a capital lease will be recorded as an asset on the balance sheet with future lease payments memorialized as a liability.
There would also be major differences on the income statement. Gone is the depreciation BlackBerry had previously recorded as an expense. Lessees with operating leases record rental expense instead, calculated on a straight-line basis over the life of the lease. Operating lease payments are included with all other operating expenses. The net effect of a sale/leaseback that is classified as an operating lease could be a reduction in EBITDA.
If a lease is classified as a capital lease, the lessee gets to claim depreciation much like under outright ownership. Otherwise capital leases are a whole different animal. Payments are reclassified as tax deductible interest and principal. Thus operating income is higher but interest expense is also greater.
At the end of March 2014, BlackBerry's balance sheet as shown in the company's annual report reflected $209 million in assets held for sale. These assets are composed principally of real estate holdings in Canada. BlackBerry recently revealed real estate investor, Spear Street Capital, is buying the Canada assets for US$278 million. Thus it appears BlackBerry will realize a gain on the sale, probably in the June 2014 quarter.
The first clearly observable impact is an increase in cash resources by approximately 18% and a slightly less impressive increase in equity by 2%. No provisions for taxes are made here as it is assumed BlackBerry in its present loss situation will be successful in shielding from taxes any gains in the asset sale.
Granted, an increase in cash is not among the most powerful value-creating events, especially for a company with operations that have historically generated ample cash. However, the divestiture of assets should help improve BlackBerry's fixed asset turnover, if and when the company eventually reports a profit and the measure becomes meaningful again. At least one brave analyst following BlackBerry expects a net profit in fiscal year 2016.
BlackBerry shares attempted a recovery in late April 2014, but have since returned to a support level near $7.00 per share. It is not likely that many investors now consider themselves made whole and they are still looking for reasons to remain in the fold. Part II of this three-part series revisits other assets on BlackBerry's balance sheet and Part III takes a look at what is not on the company's balance sheet and how those unspoken assets might sooth shareholders' wounds.
BLACKBERRY BALANCE SHEET SUMMARY
March 31, 2014
Pro Forma March 31, 2014
Assets held for sale
Property & equipment
Total liabilities & equity
Not all balance sheet categories are shown.
Source: BlackBerry Annual Report Fiscal Year 2014 ending March 2014.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.