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Evaluating BBRY Using Buffett's Arbitrage Strategy
Posted by: 20punches (IP Logged)
Date: October 2, 2013 09:08AM

BlackBerry (BBRY), the once-dominant maker of smartphones that fell on hard times in recent years, announced a $4.7 billion deal to go private a few days ago. Since then, a few of my friends have mentioned to me that the Fairfax and BBRY deal could be a very interesting situation. The announced deal is $4.7 billion; however, the market is putting a $4.15 billion price tag on BlackBerry as of October 1st. Therefore, I decided to take a closer look at this potential arbitrage situation.

In evaluating the current situation, I turned to the 1988 letter to shareholders from the Oracle of Omaha. In this letter, Buffett intelligently laid out the four questions that need to be evaluated in arbitrage situations:

(1) How likely is it that the promised event will indeed occur?

(2) How long will your money be tied up?

(3) What chance is there that something still better will transpire — a competing takeover bid, for example?

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

Let's go through the questions one by one.

(1) How likely is it that the promised event will indeed occur?

Here is what Buffett wrote for the KKR-Arcata deal: "Appraising this arbitrage opportunity, we had to ask ourselves whether KKR would consummate the transaction since, among other things, its offer was contingent upon its obtaining 'satisfactory financing.' A clause of this kind is always dangerous for the seller: It offers an easy exit for a suitor whose ardor fades between proposal and marriage. However, we were not particularly worried about this possibility because KKR's past record for closing was good."

With the Fairfax and BlackBerry deal, one of the reasons Mr. Market is putting a discount on its value is because Fairfax has not obtained all the financing needed. This worry is warranted if the acquirer has an unsatisfactory track record. However, in 28 years, Fairfax has never retreated or walked away from a deal. So in my opinion, it is very likely that the promised event will indeed occur.

(2) How long will your money be tied up?

Fairfax will spend two months conducting due diligence of the company's financial statements. That due diligence is expected to be complete by Nov. 4, BlackBerry said in a statement. Assuming the due diligence is completed as expected, then allowing a couple days for final negotiation, we will have much better clarity with regards to whether the deal will be consummated or not and at what price in five to six weeks. It is a long time for Wall Street but for value investors, five to six weeks is almost as short as it can get.

(3) What chance is there that something still better will transpire — a competing takeover bid, for example?

From what I read, there could be other bidders who are interested in BlackBerry’s services business and operating system, but only few bidders in the handset unit. BlackBerry will also need to pay Fairfax a hefty breakup fee if they can find a better deal. So if a better deal is found, it has to be a few hundred million dollars more to cover the termination fee. Furthermore, BlackBerry's CEO Thorston Heins has a huge incentive to find another deal, not necessarily a better one though, because if he lost his job after a sale of the company (not dependent on the sale price), he will get a compensation package worth $55.6 million.

It seems that a deal, whether it is with Fairfax or not, is extremely likely given the incentives of participating parties.

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc?

The market has factored in the possibility that the deal falls through. Should that be the case, the market will likely value BlackBerry the way it did before the announcement of the deal. How much? Nobody knows. From a balance sheet perspective, BlackBerry's latest quarterly filing shows that it has roughly $9 billion tangible assets and $4 billion liabilities. So net tangible assets is $5 billion, still higher than Fairfax's bid. Blackberry's intangible assets include its acquired technology and intellectual property. If we ask ourselves what the intangible assets might be worth, again, turning to the Oracle's wisdom, let's "coolly evaluate the intangible assets at somewhere between zero and a whole lot." However, with or without intangible assets, Blackberry should worth at least to the $4.7 billion bid by Fairfax.

So to sum it up, if everything turns out as expected and assuming that an investor purchases BlackBerry at today's price for $4.15 billion or $7.92 per share and that in six weeks and that the deal goes through, the investor will wind up with $4.7 billion or $9 per share, That's 13.6% in six weeks or more than 200% annualized.

Alternatively, one can do a conservative expected return calculation illustrated as following:

Let's say there is a 70% chance it will go through for at least $9. If the deal doesn't go through, let's assume BBRY drops to $7.

Expected return = 70%*1.08 - 30%*0.92 = $0.48 on $7.92 per today's closing price, or 6.06% in six weeks, or more than 66.5% annualized.

I think the odds are good. As the market keeps going up, this looks like a compelling work out.


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Re Evaluating BBRY Using Buffett s Arbitrage Strategy
Posted by: rdj1234 (IP Logged)
Date: October 2, 2013 04:02PM

I read this after reading your timely article 10/2/13 regarding # 3

(3) What chance is there that something still better will transpire — a competing takeover bid, for example?

TORONTO (Reuters) - BlackBerry Ltd has drawn interest from private equity group Cerberus and at least one other investor, CNBC said on Wednesday, quoting Dow Jones, which cited unnamed sources. Shares of BlackBerry jumped as the news hit, and were up 2.5 percent at $8.11 on Nasdaq.

(Reporting by Alastair Sharp; Editing by Gerald E. McCormick)

RDJ

P.S. iSOFT – Using John Paulson’s Merger Arbitrage Checklist here on Gurufocus combined with Buffett's list might help lower the chance of arbitrages blowing up.


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Re Evaluating BBRY Using Buffett s Arbitrage Strategy
Posted by: jsoumilas (IP Logged)
Date: October 2, 2013 05:53PM

Excellent article. Thank you.


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Re Evaluating BBRY Using Buffett s Arbitrage Strategy
Posted by: 20punches (IP Logged)
Date: October 2, 2013 06:17PM

Rdj 1234- Thanks for your comment. I won't be surprised if another bidder jumps in later. By the way, where is this John Paulson's Merger Arbitrage Checklist? Is it on gurufocus? I can't find it.


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Re Evaluating BBRY Using Buffett s Arbitrage Strategy
Posted by: 20punches (IP Logged)
Date: October 2, 2013 06:17PM

Jsoumilas - Thanks for your comments. Glad you liked the article.


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Re Evaluating BBRY Using Buffett s Arbitrage Strategy
Posted by: rdj1234 (IP Logged)
Date: October 2, 2013 07:16PM



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Re Evaluating BBRY Using Buffett s Arbitrage Strategy
Posted by: 20punches (IP Logged)
Date: October 2, 2013 09:16PM

Thank you so much, RDJ. That was super helpful!


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Re Evaluating BBRY Using Buffett s Arbitrage Strategy
Posted by: SeaBud (IP Logged)
Date: October 3, 2013 07:29AM

I do not disagree with the premise of the article. However, I think you are undervaluing one negative possibility. You seem to think that the acquisition is binary (it will or will not happen). This is not complete. The price offered by Fairfax can be lowered, and absent a higher offer (accounting for the fee that will have to be paid Fairfax if such an offer is accepted), said lower Fairfax offer will lower the average investors return (but not Fairfax's returne, as they are paying themselves).

If BBerry continues to go down the crapper over the due diligence period, I would not be shocked to see the offer price go down (say 25% chance). I think it HIGHLY unlikely that another bidder will buy as the cash flow to turn this business around and uncertain break up fee is an overwhelming problem for private capital, leaving only market players (ie, LG, Samsung) who trade volume, not ecosystems. Thus, within reason, whatever Fairfax offers will be the price an investor gets.

Ultimately, my guess is your assessment is correct and the offered price will be paid, but if Fairfax is bringing in coinvestors the pain of BBerry's numbers may cause them to reduce their offer knowing they have little competition for the deal. I think this carries a little more risk than presented and I will not touch it. But I respect the thesis.


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Re Evaluating BBRY Using Buffett s Arbitrage Strategy
Posted by: Cap2c (IP Logged)
Date: October 3, 2013 09:17AM


Here is the most compelling reason to believe this deal will happen...Prem Watsa in an interview with the associated press said:

"We've got a track record of 28 years of completing what we've done. We've never re-negotiated." He was on the board of BBRY for quite some time up until just recently.

His attorneys were probably aghast when he said the above in an interview because you can bet your bottom dollar that if the deal doesn't happen at $9, they'll have to deal with a slew of class action suits.


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Re Evaluating BBRY Using Buffett s Arbitrage Strategy
Posted by: 20punches (IP Logged)
Date: October 3, 2013 12:12PM

SeaBud: I appreciate your comments. It is a real possibility, although in my opinion a remote one, that FairFax could lower the bid. Thanks for pointing that out. Although this is missing in my thesis, I think my point number 4 indirectly incorporates the possibility of BBRY falls say to $7. I don't know what will happen but the expected return seems to justify a position. I won't touch BBRY either if not for the Fairfax deal.


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