Evaluating BBRY Using Buffett's Arbitrage Strategy

BlackBerry, the once-dominant maker of smartphones that fell hard times in recent years, announced a $4.7billion 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 $4.7billion, however, the market is putting a $4.15 billion price tab on Blackberry. 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, Mr. 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 Mr. 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 why Mr. Market is putting a discount to Blackberry's 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 4 November, BlackBerry said in a statement. Assuming the due diligence is completed as expected, then allowing a couple days for final negotiation and wrapping up the deal, our money will be tied up for about 5-6 weeks. It is a long time for Wall Street but for value investors, 5-6 week 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 find, 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. 

So it seems like 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.

Here, the market has factored in the possibility that the deal falls through. Should that be the case, the market will likely to 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 dollar, 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 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 6 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 6 weeks or more than 200% annualized. 

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

Let's say there is 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 6 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".