Prem Watsa either has one heck of a hole card in the BlackBerry Ltd. takeover talks, or the head of Fairfax Financial Holdings Ltd. is risking a lot of credibility on an inexplicable bluff. The way he is playing his hand, it looks like the former.
Markets have given their view on his conditional $9-per-share (U.S.) takeover offer for BlackBerry in the week since his company, Fairfax Financial Holdings Ltd., went public with it. Shares of the mobile device company finished Monday at $7.95 in U.S. trading, or 11.6 per cent below the bid. The gap says that investors are skeptical.
It is easy to dismiss Mr. Watsa's most recent manoeuvre on BlackBerry as a free option. Fairfax is only contributing the stock it already owns in BlackBerry, a stake of almost 10 per cent, and the time it takes to try to pull a deal together. Fairfax is already underwater on its BlackBerry investment, with no clear path to a fix the way things stand, so why not try taking the company private? The letter of intent he negotiated was very favourable to Fairfax. If his gambit sparks a higher bid from a rival, Fairfax can sell its BlackBerry stock and collect a break fee.
Had Fairfax put out its letter of intent and then gone quiet to complete its due diligence, it still would have been possible for Mr. Watsa to back away at some later date without too much downside to his reputation. The general view was it was a long shot, after all.
But he hasn't been quiet. In the past week, the normally reticent Mr. Watsa has been outright voluble. In multiple interviews, he has headed off most every question about his $4.7-billion proposal with confident answers. The more he talks, the more serious he sounds – and the more of his credibility he is putting on this line with this deal.
Does he have people willing to contribute the $1-billion in equity he wants? Why yes, there's more than enough, he says, though he declines to name names. Will he be able to get debt to fund the balance on reasonable terms? Indeed, Fairfax's consortium will be able to create a "very sound capital structure," he told The Globe and Mail. Does he expect to split the company up? No.
Will the price be cut from $9 a share, as many analysts expect? It's possible, but Mr. Watsa pointed out to Reuters that in 28 years, Fairfax had never changed the terms of a transaction. "We just don't do that," he told the Associated Press.
All of this bravado suggests that Mr. Watsa, who was on the BlackBerry board until recently, really has discovered something that he believes will make a difference to the company's prospects – something that the reams of analysts and journalists like me have not yet figured out. As well he should have done. He is rich and venerated by many value investors. Some analysts are rich. Journalists, for the most part, are neither.
There has to be some way to make the numbers work, even if, on the surface, they don't seem to add up.
The biggest question is around the capital structure. Taking Mr. Watsa at his word that he has equity partners, even putting up $1-billion and tossing in $500-million of Fairfax owned BlackBerry shares still means that $3.2-billion needs to come from somewhere else. Debt markets are not likely to be open in size and at compelling borrowing rates for a company in BlackBerry's situation. The $2.6-billion of cash on BlackBerry's balance sheet can't all be used to fund the purchase. The company will need much of that to fund its turnaround, whatever that may look like.
Somewhere, there has to be more cash, without splitting the company. If Mr. Watsa has found the answer, that is probably the card that he is waiting to play.
However, to belabour the poker analogy, winning this hand is not winning the game.
Mr. Watsa is fond of bringing up Fairfax's investment in the Bank of Ireland when discussing BlackBerry. Few saw the value in buying a large stake in a bank that was facing nationalization without his help. Fairfax did, and pulled together a consortium. Two years later, the Bank of Ireland investment is working out well. The lender is fixing its issues and the stock is up.
The difference may be that banks are systemic institutions that governments will generally help to survive if at all possible. Ireland's economy had also begun to right itself by 2011 when Fairfax made its investment.
BlackBerry does not have policy makers on its side in any discernible way. The company's position in the smartphone market these days is not nearly as impressive as Bank of Ireland's share of its home market, where it was among the largest lenders. And there is no sign that BlackBerry's situation is already beginning to improve, as was the case in Ireland.
All the same, Mr. Watsa and Fairfax have committed to deliver a draft of a final offer to buy BlackBerry by Thursday. When and if that happens, the stakes for Mr. Watsa's reputation get even higher.
(Boyd Erman is a Globe and Mail Reporter & Streetwise Columnist.)
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