Fairfax Financial Holdings Ltd. loves to play the value game, investing in companies when they are in dire need of financial support. But the latest BlackBerry Ltd. deal doesn't look like it came from the value investor's regular playbook.
In 2008, Mega Brands Inc. was in a major rut, but Fairfax saw some turnaround value and decided to help nurse the company through its recovery. The cost to Mega Brands: Issuing Fairfax some convertible debt – bonds that can convert to equity – that paid an 8 per cent coupon.
And in May 2009, when The Brick Group Income Fund need to raise some emergency cash, Fairfax was right there to support the retailer. But the support came at a hefty price. Fairfax bought $40-million worth of debt units, securities made up of bonds that paid 12 per cent annual interest as well as a bunch of warrants.
Now Fairfax is at it again, stepping up to backstop BlackBerry, another troubled Canadian company. But this time around the terms are much less onerous. BlackBerry Ltd. is raising $1-billion (U.S.) of convertible debt, of which Fairfax is the primary buyer, and the coupon is just 6 per cent.
How can that be? Is BlackBerry really that much safer than The Brick or Mega Brands at their weakest moments? And is BlackBerry really less risky than Student Transportation or Argent Energy Trust, both of which recently sold convertible debt with higher coupons? Neither of those companies lost nearly $1-billion last quarter.
While the relative risk levels are debatable, there's a big elephant in the room here: Fairfax is already a BlackBerry shareholder, holding 10 per cent of the company's equity.
If Prem Watsa was an outsider looking to get in on the restructuring now, he would demand much tougher terms on the debt, just like he has in the past. But Fairfax won't do that now, because it's already a shareholder. Mr. Watsa doesn't want to put too much financial pressure on the company – equity sits at the very bottom of any company's capital structure, and he doesn't want to be last in line for cash in the event of a bankruptcy. Fairfax also doesn't want to dilute its existing stake, should the new debt get converted to equity, so the 29 per cent premium that the debtholders must pay to convert their bonds into equity isn't that much lower than the average 35 per cent premium on convert deals.
Now, Mr. Watsa clearly can't do absolutely anything he wants. Fairfax has agreed to buy $250-million of the offering, so three quarters of it will have to land in the portfolios of other buyers, many of whom aren't already equity holders. And, yes, it can be tough to compare coupons today to those four or five years ago, because bond yields have plummeted since then.
But it's pretty clear that BlackBerry got a pretty favourable deal here.