Full disclosure: We have recommended a short position on BBRY before. In March of this year we recommended traders short the stock at $14.50, which worked out very well and we are back to dip into that trade again.
Losing Market Share and Shareholder Value
Blackberry (BBRY), a once dominant smartphone-maker, has slipped to the very low single digits of market share in the industry. This is a market that is moving fast, driven by distributed Android phone-makers and Apple (AAPL). Slower companies like BBRY and Nokia (NOK) don’t stand much of a chance.
The writing was already on the wall when the books closed for the year in March. BBRY had reported a net loss and although the company’s cash position is very strong the most recent earnings report in June resulted in a 42% drop before bottoming out in July. The company missed expectations by reporting a loss rather than break-even on the bottom line but the reaction still struck some investors as excessive – or was it?
The real issue is that the company didn’t come clean about sales (or the lack thereof) of its new phones. It’s likely they are sitting in inventory despite being shipped and the few details that were released fell well short of the “tens of millions of BB10 phones” that CEO, Thorsten Heins had promised to sell.
Traders do not like it when companies hide information. They automatically assume the worst and price that into the stock. However, despite the dismal sales and lack of information traders started bidding the stock up off the bottom where it is now sitting about halfway through the gap that opened in June – Why is that?
What is Control Worth?
Click to EnlargeBBRY announced last week (although it was already widely suspected) that the board is investigating acquisition opportunities. That’s great for shareholders who are otherwise probably going to be stuck in an endless whirlpool of shrinking market share, and the price immediately popped. A company like BBRY that isn’t distressed should be able to command a “control premium” when they are acquired 30%-40% above the market price. From the bottom of the market in July to the close on Tuesday, it looks like that premium has now been priced in.
The Rumor Has Been Bought
The market is pretty efficient at pricing in the potential for an acquisition. In fact, historically speaking, deals like this tend to be overpriced by the market, which can scare off potential partners. Either way, we feel strongly that the premium has been priced into the stock in the best case scenario or has been completely overpriced. There is an old saying in the market that you should buy the rumor and sell the news. We think that the rumor of an acquisition has been bought and now it’s time to sell the news.
We’ve Seen This Before
Click to Enlarge It is very true that BBRY is a much stronger company that PALM was when Hewlett Packard (HPQ) acquired the firm. However, that should only affect the total value of the deal, not the size of the control-premium or the direction of the stock itself. As you can see in the chart below, PALM’s pattern looked very similar to BBRY’s recently before they were able to find a deal. PALM was not as financially sound as BBRY so they only got a small control premium but it was almost fully priced in before the deal was done at $5.70 per share.
How Big is the Opportunity?
This is a tricky issue. Like PALM we expect BBRY to experience a few rounds of merger-euphoria before a deal could be announced. Right now premium is priced in without justifiable data on the operations side. We expect that investors are going to use this as an opportunity to sell and take profits or limit losses. That should drive the price back to pre-breakout levels under $10 per share. If momentum picks up we would expect BBRY to be trading under $8 by the end of the year as sales data is released again in late September.
This is an unusual trade recommendation for us but variety is the spice of life. Because this is a higher risk position we would suggest investors favor the long puts or perhaps a “married” call against an outright short position to protect against the very unlikely, but possible, acquisition that we are trading against in the short-term.
Recommendation: Short traders may consider a “married” out of the money call with an outright short position at current levels.
Options Alternative: Buy to open BBRY November 9 puts for 60 cents per share or less.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.