Value vs Pricing: Explaining WhatsApp’s Seemingly Insane Valuation

Depending on who you ask, talk to or read, Facebook’s $19B acquisition of WhatsApp provoked three principal emotions since the deal was announced last week – disbelief, fear and envy. Sometimes all three at the same time.

Considering that 235 of the S&P 500 companies, including venerable names such as Southwest Airlines and The Gap have market caps to the south of that magical number, at the heart of the matter lies the question – where did $19B come from?

Here to help us understand this acquisition from a Value vs Pricing perspective (one that makes a lot of sense to me) is Prof Aswath Damodaran, a Professor of Finance at NYU (his blog is eminently worth following; AFAIK, many that are interested in Corporate Finance and Valuations do), who starts off his excellent post by saying:

The first is that there are two different processes at work in markets. There is the pricing process, where the price of an asset (stock, bond or real estate) is set by demand and supply, with all the factors (rational, irrational or just behavioral) that go with this process. The other is the value process where we attempt to attach a value to an asset based upon its fundamentals: cash flows, growth and risk. For shorthand, I will call those who play the pricing game “traders” and those who play the value game “investors”, with no moral judgments attached to either. The second is that while there is absolutely nothing wrong or shameful about being either an investor  (No, you are not a stodgy, boring, stuck-in-the-mud old fogey!!) or a trader (No, you are not a shallow, short term speculator!!), it can be dangerous to think that you can control or even explain how the other side works. When you are wearing your investor cape, you can be mystified by what traders do and react to, and if you are in your trader mode, you are just as likely to be bamboozled by the thought processes of investors.

Cash flows, ROE, growth, users and valuation based on comparables (of sorts) all follow before he draws some conclusions:

  1.  If you are an investor, stop trying to explain price movements on social media companies, using traditional metrics – revenues, operating margins and risk. You will only drive yourself into a frenzy. More important, don’t assume that your rational analysis will determine where the price is going next and act on it and trade on that assumption. In other words, don’t sell short, expecting market vindication for your valuation skills. It won’t come in the short term, may not come in the long term and you may be bankrupt before you are right.
  2. If you are a trader, play the pricing game and stop deluding yourself into believing that this is about fundamentals. Rather than tell me stories about future earnings at Facebook/Twitter/Linkedin, make your buy/sell recommendation based on the number of users and their intensity, since that it what investors are pricing in right now.
  3. If you are a company and you want to play the pricing game, I think that the key is to find that “pricing variable” that matters and try to deliver the best results you can on that variable.

Go read the full post. And when you do that, don’t forget to read its near-poetic and semi-philosophical final paragraph. 

A Cynical Take On Fairfax and BlackBerry

Dan Primack, one of those people that generally has a sane-ish take on M&A and other activity, has this interesting and skeptical opinion on Fairfax Financial and Blackberry:

Fairfax Financial, a listed Canadian insurance company with some retail and restaurant holdings, yesterday announced that it has agreed to acquire BlackBerry for $4.7 billion. But all it really did was acquire some free optionality. In fact, the only way Fairfax loses money here is if it actually does the deal.

Rather than signing a formal acquisition offer, Fairfax signed a letter of intent to acquire BlackBerry at $9 per share. That’s an 8.95% premium to where BlackBerry opened trading yesterday morning, albeit well below where it was trading just one week earlier (when it opened at $10.41 per share). For the month, BlackBerry’s average trading price had been $10.59 per share. For the year, shares are down more than 30%. 

Fairfax also didn’t say where the money was coming from, save for unidentified equity investors (financial, not strategic) and faith that BofA Merrill Lynch and BMO Capital Markets can sell a bunch of bonds. Bloomberg reports that Fairfax itself won’t invest any new capital, outside of rolling over its existing 10% stake in BlackBerry.

If BlackBerry manages to find a superior offer before a definitive agreement is signed with Fairfax, then the mobile device maker would be required to pay a termination fee of around $155 million. It would rise to $257 million were a superior offer to materialize after a definitive agreement with Fairfax is in place. Both termination fees require that Fairfax has not lowered its offer below $9 per share. Conversely, Fairfax does not have to pay BlackBerry a single loonie if it pulls out of the process.There had been some Twitter speculation that Warren Buffett could be one of the mystery deep pockets, because Fairfax is being advised by Byron Trott and Fairfax CEO Prem Watsa is an annual Omaha pilgrim, but a source tells me that neither he nor Berkshire Hathaway are involved.

Sure there would be a bit of reputational risk if Fairfax walks away, but it shouldn’t be too hard for it to find a broadly-acceptable reason. After all, BlackBerry stunned the market just last week by warning of a $1 billion quarterly loss (3x analyst expectations), plans to lay off 4,500 employees and a reduction in future product offerings. There is likely some more bad news that will be uncovered during due diligence.

Prem Watsa (a former BlackBerry board director), said the following in a prepared statement: “We believe this transaction will open an exciting new private chapter for BlackBerry, its customers, carriers and employees. We can deliver immediate value to shareholders, while we continue the execution of a long-term strategy in a private company with a focus on delivering superior and secure enterprise solutions to BlackBerry customers around the world.”

That’s a whole lot of confidence, given that Fairfax hasn’t ever done a deal like this 
before. According to the CapitalIQ database, the company’s largest M&A transactions have all been for less than $2 billion — with no control stakes in the technology sector.

Perhaps Fairfax was attracted to the BlackBerry balance sheet, which currently features zero debt. Or maybe there is some sort of Canadian nationalism in play here. But it’s kind of hard to imagine right now that an insurance company (with a handful of retail and restaurant assets) has figured out a workable investment thesis for a dying smartphone company that every private equity firm and strategic tech acquirer has passed on (save for launching a massive patent war that could end up costing far more than it creates).

So, for now, I’m viewing this as a 10% shareholder’s last-ditch attempt to get someone else interested in BlackBerry. Yes, it sounds incredibly cynical. But right now I can’t come up with a better explanation for what Fairfax is doing. 

On the face of it, makes sense…but Prem Watsa has a non-insignificant stake in BlackBerry that he acquired at $17 (as opposed to the $9 that $BBRY is valued at now), and he was on the BB board until very recently. So, even if you discount the obligatory “we are excited about the future” press statement, I wonder if he/Fairfax Financial does have a plan.

An Enterprise play? A “sum of the parts” play? Something else?

The world, or at least some part of it, waits to find out. 

Shareholder Activism Pays. $70m, in Dell’s Case

Michael Dell and Silver Lake have finally won control of Dell. 

Those that got into Dell shares at more than the final $13.88 a share buyout price in the last few years obviously lost. (But $13.88 > $10 or $5 which is where Dell’s stock might have headed in time but for this move, so this was probably the best outcome for them.) And some would say that Carl Icahn, the bete noire of troubled companies everywhere, also lost. 

But that’s lost as in not being able to get what he originally wanted, or said he wanted:  $22.81 a share.

By more conventional means of success and gains, he didn’t do too badly for himself though, as Steven Davidoff writes on The NYT’s DealBook:

Shareholder activism pays. Let’s face it, $70 million for Mr. Icahn is not a huge payout, but it is a nice return for six months’ work. While Mr. Icahn is a unique force, merger activism, either fighting a deal or arguing for an increase in price, is going to increase. But the dynamics of merger activism also drive shareholders toward a deal. The only issue becomes price. So, expect merger agreements to be negotiated not only with a mind toward competing bidders but how the parties can fend off these types of activists, regardless of whether it helps shareholders.

Steven’s full piece, where he notes 6 other “lessons” for boards, companies, shareholders and buyout firms is well worth a read. 

What’s BlackBerry Worth?

BlackBerry made the news at the end of last week for saying it was open to being bought out. By whom, is the question though.

Dan Primack, as usual, has some interesting comments in his newsletter today: 

On paper, a BlackBerry leveraged buyout does make sense. The company could be viewed as a bargain, given that its $4.8 billion market cap (pre-leak) is a perverse rearrangement of the $84 billion it was valued at back in 2008 (and 19% lower than where it began the year). More importantly, it reported $630 million in operating cash-flow last quarter and absolutely no debt (two stats that make LBO lips salivate).

Moreover, there is unlikely to be competition from strategic bidders. It’s hard to imagine Silver Lake and Michael Dell would spend another $5 billion or so after having just been forced to stretch for Dell Inc., while an Icahn-owned Dell would be more seller than buyer. China’s Lenovo or HTTC are always rumored to have interest, but it’s hard to imagine such a deal flying with Canadian regulators (let alone what would happen to vendor agreements with U.S. government departments). There are arguments that companies like Apple, Google or Microsoft may want select piece of BlackBerry — such as its secured network assets or patents — but being amenable to a take-private buyout is much different than enabling a strip sale.  And even at today’s depressed valuation, BlackBerry’s parts may be too rich for strategic interest.

So back to the buyout talk. Or lack thereof, since companies only leak such “openness” if no one is actively beating down their door.

On The WSJ, David Benoit summarizes BBRY’s valuation per the analysts at Nomura and other firms, leading with the hardware business that’s valued at all of $0.

Hardware: $0 – The analysts are consistent on one piece of BlackBerry’s valuation: BlackBerry’s phones, which generated more than 60% of the company’s revenue last year, have no value. “Given our belief BlackBerry’s hardware business will struggle to return to profitability given increasing smartphone competition, we struggle to assign any value to the hardware business given our belief the most logical acquirer of BlackBerry would likely attempt to transition BlackBerry’s subscriber base to its own competing smartphone products or ecosystem,” Canaccord analysts wrote.

The rest of the company (the services business, patents, licenses and $2B in cash!) adds up to anywhere from $7.30 a share to $15 a share, which is great if you work for them or hold their shares.

But the $0 valuation for the phones business – a business that, pre-iPhone, dominated the world – should make everyone (re)read Andy Grove’s “Only The Paranoid Survive”. And, it should give corporate strategy departments in companies that dominate their industries many, many sleepless nights. 

Tweets Cause Ratings + Ratings Cause Tweets


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In other words, a two-way causal relationship between Twitter and TV that Nielsen uncovered using a “time series” statistical analysis. 

There are two implications for this:

1. This is going to (further) accelerate TV networks’ advertising spend (and dependence) on Twitter.

2. Those that advertise during shows that have been promoted on Twitter will see additional audience engagement (which Twitter was already able discern and amplify, thanks to another recently unveiled innovation).

A major ++ for the TV + advertising ecosystem (and Twitter’s ad revenues)…

Sony to Dan Loeb: Thanks For the Break-up Idea, But We’re Good

So a few weeks after Dan Loeb (whom George Clooney criticized the other day) told Sony that (a) he owned 7% of Sony and (b) that Sony should essentially break itself up (see my May 15 piece for some background and history) in order to “unlock shareholder value”, he got an official response back from the venerable Japanese giant. 

As Daisuke Wakabayashi and Ben Fritz write on the WSJ (paywall), 

In a letter released on Tuesday, Sony said it considered the proposal made by Mr. Loeb’s Third Point LLC—which has said it owns about 7% of Sony’s shares—and concluded that the company is better off owning all, and not part of, the content businesses because of their increasing value in the rapidly changing technology industry and their potential to drive growth at the electronics unit. In addition, Sony said that should the company require additional capital for restructuring its electronics business, it has alternative sources available.

“Should we require capital, or in the event of unanticipated events, our priority would be to raise it without selling a portion of an asset fundamental to our growth strategy, and without unnecessarily burdening Sony’s ability to execute our business strategy for both entertainment and electronics,” wrote Sony Chief Executive Kazuo Hirai.

Your move, Mr Loeb. 

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