Late last week, smartphone maker Blackberry (click ticker for report: ) preannounced terrible second quarter results. Revenue likely declined approximately 43% year-over-year to $1.6 billion, which is nowhere in the ballpark of consensus estimates in the $3 billion range. This amounted to 3.7 million phone sales, far less than the number of units Apple (click ticker for report: ) sold during the first weekend of its iPhone 5S/5c release. The firm will post an operating loss of $950 million to $995 million driven primarily by a pre-tax inventory charge of $930 million to $960 million. Cash fell to $2.6 billion, and the firm announced that it would lay off 40% of its global staff, leaving the company with 7,000 total employees.
Things were not looking very good, but Fairfax Financial (FFH), which owns 9.9% of the company, may have to come to rescue shareholders. Fairfax and Blackberry signed a letter of intent allowing Fairfax to acquire Blackberry for $9 per share in cash ($4.7 billion total value) pending a six-week due diligence period. While it may not look like a great value to shareholders who purchased the company when it was trading near $18 per share, the deal may look rich for a company that seems destined for the scrap heap.
Why Would Watsa Acquire Blackberry?
Fairfax Financial CEO and largest shareholder, Prem Watsa, is often referred to as the Warren Buffett of Canada. Watsa has experienced some great investment success, but we have a difficult time viewing Blackberry as a Buffett-esque investment. Not only has the company clearly lost its competitive edge to the likes of Apple’s iPhone and the various phones running Google’s Android (click ticker for report: ), but the brand has fallen behind long-time mobile laggard Microsoft (click ticker for report: ). Blackberry’s future cash flows are incredibly uncertain and look poised to decline.
This begs the question: why would Watsa acquire Blackberry? Let’s not forget that the deal is predicated on a letter of intent and not a fully-financed deal, granting Fairfax six weeks to perform additional research. If Fairfax looks at the books and decides it isn’t worth pursuing, the firm will receive $0.30 per share, or roughly $157 million as a breakup fee. While this seems great for Fairfax, let’s not forget that Fairfax has already sunk many times this amount into the company already. If the deal falls through, Fairfax will probably exit Blackberry at a substantially lower price.
A Deep-pocketed Bidder
Fairfax could also be hoping for another bidder to come around, perhaps looking to scoop up some patents. Rumors of generous offers from Microsoft and Google always swirl when patents are the subject of interest, but we simply do not see either company ponying up for patents of an operating company that is quickly heading towards irrelevancy. Plus, both companies have already acquired phone makers with patent portfolios, so neither needs to acquire Blackberry.
Fairfax’s Berkshire?
Truthfully, Watsa may see the writing on the wall that Blackberry is a cheap stock with an operating business quickly declining. Perhaps he thinks he will be able to break up the company for a better value, or he is overly optimistic about the firm’s prospects, like Buffett was over Berkshire Hathaway’s textiles (BRK.A). Fairfax might simply be doubling down with little hope of recovery.
There is also the reality that Blackberry won’t require any additional financial commitment from Fairfax. The firm will look to add more debt and equity investors to come up with the $9 per share offer, so realistically, it won’t cost much more for Fairfax to take the company private.
Valuentum’s Take
Blackberry has undergone a spectacular fall from grace, and conditions have become so challenged that the firm had to offer an acquirer an extremely generous offer to even look at its books. Without financing secured, the deal could fall through, and frankly, we wouldn’t be surprised if Watsa backed out of the deal when he finds little interest from other investors. Regardless, we have no interest in shares of the Canadian phone maker at this time.
RJ Towner owns shares of the following companies: AAPL