The recent drop in BlackBerry Ltd.’s (TSX:BB)(NASDAQ:BBRY) share price could, ironically, improve the company’s upcoming quarterly earnings report for fiscal second quarter 2018 (Q2 2018) due on September 28, 2017, if the share price does not rebound back to its May 31, 2017, levels by the end of August.
The boost to BlackBerry’s bottom line would result from the company’s accounting and fair-value reporting for its outstanding 3.75% convertible debentures.
Last quarter, BlackBerry reported a significant (pre-tax and after-tax) charge on its income statement of US$218 million in a line item titled “Debentures Fair Value Adjustment”, and we might see an income statement gain on this line item this quarter.
How does the share price affect the fair value of the convertible debenture stock?
BlackBerry had an aggregate principal convertible debenture stock outstanding of US$605 million as of May 31 2017, which is set to mature on November 13, 2020.
Each US$1,000 of principal debenture debt can be converted, any time, into 100 common shares of BlackBerry at a fixed price of US$10 a share.
It’s standard accounting procedure that changes to the fair value of debt securities be reflected in the company’s books. BlackBerry elected the fair-value option to account for the debentures and periodic revaluations that are required under the U.S. GAAP financial reporting framework.
On a quarterly basis, BlackBerry has to adjust the fair value of its outstanding debentures as the company’s share price and general interest rates change.
The sharp 52% share price jump from US$6.96 on February 28 to US$10.57 on May 31, 2017, was great for investors, but the company had to charge the income statement more than US$200 million to reflect the increase in the fair value of the outstanding debentures.
This was an expense to the firm.
However, as BlackBerry’s share price declines, convertible debenture holders suffer fair-value losses, and this should be reflected as a gain to common shareholders on BlackBerry’s income statement.
BlackBerry shares have shed almost 16% of market value from their May 31, 2017, closing price of US$10.57. The share price picked at US$11.39 on June 1, but has since declined to US$8.90 levels as of August 15.
If the shares continue to trade in this range until the end of August, then BlackBerry may report a significant gain on the income statement related to the fair-value adjustment for the convertible debentures.
I am expecting a downward revision on the fair value of convertible debentures as the company reports Q2 2018 results on September 28, 2017, from the US$809 million closing balance last quarter.
However, it is possible that that some portion of the debentures could have been converted as the stock price shot past the US$11 mark in June, so the effect of the debenture fair-value adjustment may not be that substantial this quarter.
Investor takeaway
Some analysts argue that the “Debentures Fair Value Adjustment” line item should not be considered in normalized (adjusted) earnings, as it appears to be a non-operating item that lies outside management’s control. However, I beg to differ, since the financing decision is management’s direct operating responsibility, the effects of which affect normal business operations.
The company’s income statement shall continue to incur charges or record gains as long as the convertible debenture stock remains outstanding and the stock price remains volatile.
I wish to see BlackBerry’s income statement gaining primarily from revenue growth and cost savings, though, and not from debenture fair-value adjustments.
Investors will definitely not celebrate income statement gains that emanate from share price declines.
It would serve the company well to make an acquisition that boosts operating revenues and profitability going forward, while investors await progress on the autonomous driving front as well as accelerated revenue growth in the software and services business portfolio.
