As BlackBerry shares swoon, a different kind of buyer emerges

News Report: BlackBerry Draws Interest of Cerberus

So, it has come to this.

The share price of BlackBerry (BBRY:Q, BB:TSX) has dropped so low, despite the $9 Fairfax LOI (see prior post “BlackBerry deal tests limits on M&A creativity” Sept. 24-13), that distressed players from the Private Equity space are asking for access to the dataroom (H/T WSJ). I can see why the market pushed BBRY up once the news broke, but I’d recommend against ordering any champagne on the news.

As any experienced U.S. investment banker will tell you, there are three broad categories of buyers of technology companies: Strategics, Private Equity firms that want to add to an existing platform company in the same or adjacent space, and “guys looking for a deal”. As you can imagine, with more than 13 years of history financing innovation companies here at Wellington Financial, we’ve seen plenty of tech-related M&A processes. Most good innovation firms are eventually sold, rather than taken public through an IPO, and we get a good view of each one as it plays itself out. Whether the outcome is a happy one or otherwise, a trade sale is usually how it turns out.

Given the size and scope of BlackBerry, the universe of strategic buyers isn’t very large — although it is definitely large enough. That none of Cisco, HP, IBM, Microsoft, Samsung, etc. are expressing an interest was a bad sign for BBRY investors hoping for a premium bid, as I posted six hours before the $9 Fairfax proposal was made public (see prior post “BlackBerry moves suggest M&A process failing to produce a strategic buyer” Sept. 23-13). Despite hankering to look at RIM previously (see prior post “Can’t ignore Lenovo’s interest in RIM” Jan. 24-13), Lenovo may not be big enough to do the deal without overseas financial help, which may cause challenges for certain North American government customers who might fret about the security of their transmissions.

The tepid strategic interest may impact the brewing Fairfax proposal, since CPP Investment Board exec Andre Bourbonnais has stated publicly that his team won’t play unless a strategic is part of the plan (via Globe and Mail):

for any deal to succeed, it needed to include a “strategic” player, such as another technology firm, to help turn BlackBerry around. “My view is it needs the right kind of investor,” he said.

I agree with him completely, and it seems to be a tall order for Fairfax to raise another $1 billion in equity from pension plans and $3 billion in bank debt financing should firms like CPPIB not play ball. Once Mr. Market came to appreciate the weakness of the as-yet-unfinanced Fairfax concept (see prior post “BlackBerry deal tests limits on M&A creativity” Sept. 24-13), shares fell 15% below the $9 headline figure.

In comes Cerberus, sensing a deal.

I don’t blame them. Blackberry just reported $12.5 billion of assets, so with a $4.7 billion Fairfax proposal in the works (just over 0.5x book value), it would be irresponsible for firms like Cerberus or Gores Group to not kick the tires in the Waterloo dataroom. That Blackberry has only $4 billion of liabilities against that asset pool will appeal to the clinical financial types. Here’s what they have to work with:

Cash and other: $2.34B
A/R and other: $1.96B
Inventory: $0.9B
Income taxes receivable: $0.46B
Other current assets: $0.7B
Assets held for sale: $0.12B
Long term investments: $0.22B
PPE: $2.1B
Intangibles: $3.5B

At first glance, the balance sheet tells Cerberus that paying $4.71 billion for $8.5 billion in net stated assets (under GAAP) could be a winner. The stumbling block, which is undoubtedly hurting Fairfax’s pitch to Bank of America and BMO’s credit groups, is the $368 million of cash outflows during the most recent quarter. Simply put, if nothing changes in the cost structure, BBRY has less than seven quarters of cash available to keep the lights on.

Now you understand why the Blackberry Board had to take the tough decision to announce a 40% layoff during the middle of a sale process, something you’d never do if you had a choice, as I wrote last Monday.

The thing about a potential Cerberus bid is that it will have none of the romantic cum nationalistic emotion that might be, in some small way, driving Fairfax and others to try to make a deal work. Their data room analysis will be simple, as complex as this all really is:

– how much could we raise if we were to sell or licence the $3.5 billion of patents and intangibles?
– what cash could be raised from the $2.1 billion of property, plant and equipment?
– how much working capital will be required versus the current $2.78 billion level?
– what will it take to get the business to cash flow break even?
– how long will the core revenue last while we jettison assets to cover the original purchase price?
– which strategic will buy it from us down the road, and at what valuation?

As much as some in the media think buyers are “warming to the idea” of acquiring Blackberry, make no mistake. This is about getting a deal. Where were these “buyers” 18 months ago when Goldman Sachs had the strategic alternatives mandate and BBRY shares were at $18? Or even six months ago when the mobile industry was tickled with anticipation for the new Q10? Again, BBRY shares were in the $17-18 range.

These buyers are only now raising their hand in the wake of what appears to be a weak Fairfax proposal, and a 50% drop in the share price post the Q10 launch. A deal may actually happen, and I-bankers will see their M&A fee, but don’t expect this new cohort to overpay for the asset (see prior post “BlackBerry: don’t bet on a frothy, ‘quick auction’” Sept. 5-13).

That’s just not what they do.

MRM
(disclosure: the photo is by Irving Penn, Butchers, Paris, 1950)