- BlackBerry's restructuring efforts save the company $156 million in interest payments that would have been due over the next 3 years.
- Move improves BlackBerry's balance sheet.
- It's primary creditor lending at a lower interest rate, goes to show that the company offers a reduced amount of risk, now.
BlackBerry (NSDQ:BBRY) completed its debt restructuring earlier this month, but ever since the announcement for the same was made, the stock price of the smartphone vendor has collapsed by about 10%. A few investing and trading forums are abuzz with discussions over whether this is a positive event or a negative one for the company. So let’s take a closer look at the development to have a better understanding of it all.
What’s the fuss?
- Well, BlackBerry recently redeemed its outstanding $1.25 billion convertible debt carrying a 6% interest rate, that the smartphone vendor had raised from Fairfax Financial back in 2013. The general perception amongst misinformed market participants is that BlackBerry knew about the maturity date of this debt for years, yet it couldn’t furnish its repayment, and rather had to raise another $605 million debt in the form of convertible debentures carrying a coupon rate of 3.75% to complete the repayment of its $1.25 billion convertible debentures. This certainly looks bad if you put it this way.
- The second issue is that BlackBerry chose to raise more debt, instead of shutting down its loss-making handset division that has hemorrhaged cash for several years now. If a company has a lot of debt on its books, and its survival is at risk, any board would tend to shut down their loss-making business divisions to make their operations sustainable. So, a few commenters pointed out that BlackBerry should have chosen to shut down its bleeding handset business instead of raising more debt, as it pushes the company’s breakeven point even further. But is the shut down really required?
- The third factor at play here is that the initial $1.25 billion debt was in the form of convertible debt. This meant that BlackBerry had to pay Fairfax Financial a 6% interest rate on the outstanding debt until the debentures matured. And if in the process, BlackBerry’s share price rose above $10 per share, Fairfax Financial had the right to convert the outstanding debentures into shares. This was a win-win situation for Fairfax, and a not so good deal for BlackBerry shareholders, as their company was susceptible to a massive round of dilution if their stock did well.
- But amid BlackBerry’s restructuring efforts, the company redeemed $1.25 billion worth of convertible debentures and raised another $605 million worth of convertible debentures. This essentially means that BlackBerry shareholders are still prone to the dilution risk that we just discussed. BlackBerry could have raised non-convertible debt to get its shareholders out of the dilution trap. So it looks like the company’s board clearly could have done more for their shareholders, as the dilution threat pretty much limits the stock from going over $10 in value.
Also Read: 3 Positive Triggers For BlackBerry Ltd Stock
Now that we have discussed the negative side of this development, let’s take a look at the bright side as well.
- First of all, the $1.25 billion worth of convertible debentures were not due for maturity in 2016. They carried a 7-year term that extended till 2020. So BlackBerry was under no obligation to repay the debt early, but it did anyway, to save on interest expenses. I went through BlackBerry’s past press releases and found the terms of the deal, which are mentioned below:
“Under the terms of the transaction, the Purchasers will subscribe for U.S. $1 billion aggregate principal amount of 6% unsecured subordinated convertible debentures (the “Debentures”) convertible into common shares of BlackBerry at a price of U.S. $10.00 per common share (the “Transaction”), a 28.7% premium to the closing price of BlackBerry common shares on November 1, 2013. The Debentures have a term of seven years. Based on the number of common shares currently outstanding, if all of the U.S. $1 billion of Debentures were converted, the common shares issued upon conversion would represent approximately 16% of the common shares outstanding after giving effect to the conversion.”
- Now let’s talk about interest burden reduction. BlackBerry retired $1.245 billion debentures carrying a 6% coupon rate and raised another $605 million convertible debt at 3.75% rate due in 2020. Notice that there’s a difference of 225 basis points between the two debt offerings. Since the interest payments are to be made out on an annual basis, we can arrive at the conclusion that BlackBerry saved about $156 million in interest payments that were due over the next three years. So this debt restructuring actually makes BlackBerry’s breakeven point a bit closer than it earlier was, whilst improving its balance sheet.
We have established so far that BlackBerry was under no obligation to prepay its debt, but it did anyway, to save $156 million on its interest payments. Now let’s take a look at the debt raised.
- Well, raising debt isn’t actually a bad idea in the current low-interest rate scenario. Several well established companies such as Apple and Intel have raised debt, even though they have a lot of cash balance, to pay dividends, fund buy backs or to propel growth. It appears that BlackBerry is doing the same as it had nearly $2.5 billion in cash and equivalents at the end of Q1FY17, which is sufficient to repay its entire debt. Instead of taking cash out of its business, the company’s board and its management are essentially taking a bet that they will be able to generate returns in excess of 3.75% out of the newly raised $605 convertible debentures. So this is actually a good thing for BlackBerry shareholders.
- We also have to note here that Fairfax didn’t convert any of its $1.25 billion convertible debt. This essentially means that the dilution risk hasn’t come into play, at least not yet.
- There’s one last thing worth paying attention to. When BlackBerry raised its $1.25 billion debt back in 2013, its survival was at stake. So Fairfax Financial accordingly offered debt to the company at a high 6% debt due to the risk involved. But now the same firm agreed to restructure BlackBerry’s debt, lent $605 million at a much lower 3.75%. This goes to show that Fairfax believes that BlackBerry is a much healthier company now, carrying a reduced risk of bankruptcy. So this should actually serve as a sentiment booster for the smartphone vendor’s shareholders.
Putting it all together
I’m of the opinion that the debt restructuring is a good move forward by BlackBerry. It allows the company to take advantage of the low interest rate scenario, without taking away its financial flexibility. So shareholders should rejoice rather than feeling bogged down.