BlackBerry (NASDAQ:BBRY) shares closed 6% higher on Friday after a research report from Citron Research (here) suggested a minimum price target of $15 per share for the handset maker. I have previously written about BlackBerry and have consistently maintained that BlackBerry is misunderstood by the market and that the company could experience a major turnaround in 2014. To start with, I argued that Fairfax Financial's attempt to take the company private at a price per share of $9 was ludicrous. This would certainly have been a good deal for Fairfax Financial and Prem Watsa, but not for BlackBerry shareholders who would have been deprived of substantial amounts of recovery potential.
Usually, when a company experiences a massive decline in market capitalization (BlackBerry has lost about 93% of value from June 2009 to December 2012) the naysayers take over who already see the company in bankruptcy and are quick to judge every investment in a struggling company as a lost investment (just look at the amount of negative articles on BlackBerry here on SA). But here is the catch: Investing doesn't work like that. Any student of market history will realize that the darkest hour for either the entire stock market or a specific company, can be a great entry point. This is especially true for long-term investors who buy when the price setting mechanism is determined by fear and panic. A long-term investor doesn't care about short-term price swings or whether his position is in the red because of short-term headline risk. Ultimately, this strategy has gotten Warren Buffett rich.
The contrarian investor tries to identify value where others only see problems. My investing experience seems to reveal a very peculiar, counterintuitive and almost comical notion: The lower the confidence of investors in the future prospects of a company, the stronger the dismissal of a position that goes against the crowd, the more lucrative that opposing position turns out to be. Investors who had the nerve to buy financial stocks in 2009, healthcare stocks in 2010, Bank of America (NYSE:BAC) in 2011 and mortgage insurance companies in 2012 know what I am talking about.
Now, I want to ascertain that I am not a market timer. I do not at all have superior market timing skills. But buying stocks that nobody wants, which basically reflects the contrarian mindset, appears to be working out well in the long-term. The contrarian mindset also leads to some curiously strange thinking patterns: Bad news are good news. I argued at the time that the collapse of BlackBerry's buyout by Fairfax Financial was a good thing for shareholders and I aggressively recommended BlackBerry at $6.50 (even though the transaction fallout implied the evaporation of what could have been regarded as a minimal takeover premium).
Investors make one crucial mistake when evaluating distressed companies: They extrapolate current conditions. In boom phases investors extrapolate current conditions and shares consolidate as a result, in trough phases investors also extrapolate, are overly pessimistic and sell shares. It is not new information that the average investor sells shares at the bottom and buys at the peak. Investors are probably well advised to invert their thinking: Problems, more often than not, are opportunities in disguise.
As of November 30, 2013 BlackBerry showed $2.3 billion as cash and another $788 million as short-term investments on its balance sheet. Total cash and cash equivalents totaled nearly $3.1 billion or about $5.87 per share. On December 9, 2013 BlackBerry shares were trading at $5.75 which implies that BlackBerry's market capitalization (at least for a short period of time) was lower than the cash and securities value on its balance sheets. Investors would have gotten BlackBerry's patents, its messaging and service business for free. How is that for a margin of safety?
It's high cash position also gives the company the necessary fire power to conduct its business and invest in its growth strategies. A near-term bankruptcy is not a credible scenario, no matter what bears want you to believe.
BlackBerry has substantial, inherent value. I peg the value of BlackBerry's Messaging and Service Business at $3.5 billion and its patent portfolio is probably worth around $2.5 billion. In Citron's research report about BlackBerry the company notes with respect to BlackBerry's patent portfolio:
Analysts have pegged different value on BlackBerry's patent portfolio, ranging from $1 billion to $3 billion. The company was ranked 20th in number of US patent approval for 2013 with 1334 patents approved over the course of the year. Its market capitalization today is a small fraction of virtually every single one of the companies ranked in top 30.
On a per share basis (BlackBerry has about 526 million shares outstanding) this translates to a value of around $11.41 per share (see my original core asset break-down per share for BlackBerry here). Adding cash and securities worth $5.87 per share leaves us with an intrinsic value of $17.28. BlackBerry's hardware business is surely cause for headache and the current market value is likely to be zero. The handset industry has provided plenty of examples of loss-making device businesses and Nokia's (NYSE:NOK) and Siemens' (SI) device businesses come to mind (Siemens' loss-making mobile phone unit was sold to BenQ which got a bargain deal on the transferred patent portfolio plus it got a couple of hundred million Euro as teaser money).
BlackBerry is not dead but already in recovery mode. BlackBerry's deal with Foxconn is intended to cut production expenses and profit from the experience and production efficiencies of a large-scale Asian manufacturer which is a good, first step. However, I think that BlackBerry will sell its device business even if it means that a potential acquirer will need to be lured with an additional check. Citron's research note and upbeat valuation estimate underscores what I have consistently been writing about over the last three month: BlackBerry will likely defy the mindless and unconstructive pessimism it presently faces and the company might even turn out to be the best recovery story of 2014. Contrarian long-term BUY with a target price of $17.
Disclosure: I am long BBRY, BAC. 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.