Let’s Make A Deal: BinShopping Edition

by Dan March 30, 2011 8:26 am • Commentary

Since the SPX‘s intraday low on March 16th we have seen a bunch of M&A activity that has certainly helped buoy the recent enthusiasm in the market and helped propel the major indexes within striking distance of the previous 52 week highs.  A couple of the announcements caught my eye in particular (EBAY‘s bid for GSIC announced Monday night, and Valeant‘s hostile bid announced last evening) as both targets were trading within 8% of their 52 week LOWS and both were well off their 52 week highs (~37% and ~17% respectively).

GSIC 1 year Chart chart by LiveVol
1 year

-Yesterday, in the wake of the GSIC / EBAY the WSJ highlighted some options activity that suggested “Rumor-Driven Trading Signals Risk Is Back”:

Deal rumors, including thin ones, are driving more activity in the options market of late, a sign traders have grown more comfortable taking on risk. Tuesday’s activity in the options market included bursts of volume in bullish calls to buy shares in software company Adobe Systems, retailer Macy’s and a handful of other stocks, in trading analysts linked to unsubstantiated buyout chatter.

ADBE and M have definitely been rumored takeout names in the recent past, but as I am scanning the potential universe of rumor names I would much rather focus on those stocks that have been down on their luck, most closely resembling the announcements of this week.  One such company that comes to mind is Akamai, which is currently down 19% ytd, ~9% off its almost 11 month lows made earlier in the month and ~30% off its 52 week high.

-AKAM’s primary business is providing services for content and application delivery over the Internet.  The most recent spat of take-over chatter regarding AKAM got going this past January when Verizon announced that they would pay ~$1.5billion for Terremark a similar but smaller player than AKAM.

-At the time the rumored potential acquirers were large telco and/or cable companies, and as always GOOG, AAPL, MSFT, CSCO.  This list could even be expanded to an even broader group when you consider the almost $8Billion deal that INTC announced for MFE back in August 2010 which by most observers seemed expensive and an odd fit at best.

-I have no knowledge and or conviction that AKAM should even be considered on a short list of potential targets but since the companies earnings/guidance miss back in Feb and the depressed stock, the company clearly fits in the context of the deals we have seen just this week.

-If you are of the mindset of adding some low conviction speculative m&a plays in your portfolio then AKAM could be a decent candidate given the amount of chatter in the past and the potential strategic fit for the right acquirer.

-I would avoid April options as you will want to give yourself some time for this to play out and give the company some time to right the ship if a deal doesn’t happen.  Company will likely report in May expiration which could be a place to start if you think the earnings announcement/guidance could be a catalyst but I would prefer to look at AUG of JAN12.

TECHNICALS: As stated above this stock has traded in a fairly wide 52 week range, but as evidenced by the chart had a meteoric rise from it’s mid teen lows in 2009 to the mid 50s highs made late last year.  Technically it appears to be at a big inflection point, either fundamentals begin to shore up and the street re-kindles the ol flame that drove valuation to the stratosphere, or we could see a break below the previous low which probably signals a $30 stock.

18 Month AKAM Chart chart by LiveVol

2 WAYS TO PLAY FOR TAKEOUT DEPENDING ON YOUR RISK TOLERANCE:

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1. Define Risk- BUY Out Of the Money Call Spreads

TRADE: Buy the AUG 45 / 52.5 Call Spread for ~1.10

-Buy Aug 45 call for 1.70

-Sell Aug 52.5 call at .60

Break-Even on Aug Expiration:

Upside: Stock btwn 46.10 and 52.50 can make up to 6.40 or ~17%, above 52.5 make full 6.40.

Downside: stock btwn 46.10 and 45  lose up to 1.10 in premium paid, below 45 lose all 1.10 premium or ~3% of underlying.

TRADE RATIONALE: this is a low probability play where the only way you make money is if you get a massive move back towards the previous highs.   I chose these strikes as I think if there were a deal the company likely wouldn’t settle for anything lower than a range similar to the previous highs, similar to what we saw this week.  But again you don’t want to litter your portfolio with trades like this because once you finally get the big one it will likely just make up for all previous failures, do some work, make a decision to put this trade on if you are also comfortable with the companies near and long term prospects.

2. Increase Your Odds of Success with Added Risk, Buy Call Spread Risk Reversals

TRADE: Sell the Aug 30 Put to Buy the AUG 40 / 50 Call Spread

-Sell the Aug 30 Put at ~1.00 and

-Buy the Aug 40 / 50 Call spread for ~2.30 (buy Aug 40 call for 3.20 and Sell Aug 50 call at .90)

Break-Evens on Aug Expiration:

Upside: Stock btwn 41.30 (up ~8.%) and 50 (up ~30%) you can make up to 8.70 or ~22=% of the underlying

Downside: stock btwn 41.30 and 40 lose up to 1.30 or ~3% of the underlying, btwn 40 and 30 lose all 1.30, BUT WORST CASE stock below 30 (down 21%) you are Put the stock and lose the 1.3o in premium.

TRADE RATIONALE: this trade adds considerable risk as opposed to just buying a call spread but the probability of making money increases dramatically as you start participating to the upside very quickly.  If you are inclined to buy the stock here this could be a great alternative as the worst case you are Put the stock ~$8 lower on Aug expiration if you are wrong.  2 quick points; that Put you are short will take up margin in your account and if the stock starts to move lower you will obviously have mark to market loses as if you were long the stock…..

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