Earlier today I detailed Bernstein’s Upgrade of PCS (below), where they suggested:
We believe this presents an attractive opportunity. Investors are, in effect, getting two free options. First,there is a free option on a successful merger and the realization of merger synergies. And second, there is the free option that Sprint elects to make a counterbid for MetroPCS
All this discussion about “Free Options” got your friends at RiskReversal a little excited and we just couldn’t let it drop. In today’s MorningWord (included below, after trade idea), I detailed that while Bernstein thinks the stock currently discounts a counterbid and an ensuing bidding war btwn Sprint and Deustche Telecom (DT), the options market is viewing this a tad different as short-dated implied vol has shot up as a result of premium buyers late last week.
Given Sprint management’s recent talk of industry consolidation, and their almost deal with PCS earlier in the year, I would be surprised to see Sprint shut out from their predicted consolidation.
With Implied Vol bid in Oct and Nov, we think it makes sense to sell downside puts to finance the purchase of upside calls playing for a Sprint Counterbid for PCS. We also think that despite some provisions in the DT/PCS deal regarding PCS’s board ability to recommend a Sprint deal before shareholders reject the T-Mobile combination, and the $150 million break-up fee that PCS would owe DT, that Sprint is likely to show up to the party and soon, as some M&A watchers have suggested that Sprint would have a much more difficult time acquiring the combined T-Mob/PCS entity inthe future. Remember that AT&T’s bid for T-Mob was rejected by the FTC last year.
I want to make a short term trade that Sprint comes in with a possibly hostile higher bid, and then DT is forced to sweeten the deal, both scenarios sending PCS higher. I place a lower likelihood that Sprint states that they will not bid, but if they ended up passing on a bid, and there was no other bidder, PCS would likely trade back towards $10-11 range until investors get a better understanding for the complicated DT/T-Mob deal structure.
TRADE: PCS ($12.66) Bought Nov 11/14 Risk Reversal for .05
-Sold 1 Nov 11 Put at .45
-Bought 1 Nov 14 Call for .50
Break-Even On Nov Expiration:
-Profit stock 14.05 or higher
-Worst case I am put the stock at 11 and have losses below (plus .05 premium that I paid).
-Btwn 11 and 14 I lose up to .05 with max loss of .05 btwn the strikes.
On a mark to market basis prior to Nov expiration, I will make money as the stock trades to the call strike that I am long, or lose money as it trades toward the put strike that I am short.
**The NYT Dealbook blog had a what I thought to be a very useful breakdown of the mechanics of the proposed DT/PCS deal here.
MorningWord 10/8/12: Free Options Aren’t Always Free in Vol Terms
MorningWord 10/8/12: It was probably hard to miss last week, but wireless telecom m&a is back, not exactly back like the early part of the last decade when Deutsche Telecom paid $50 billion for Voicestream in July 2000to create what would ultimately be T-Mobile in the U.S., or the $35 billion acquisition announced by Spring for Nextel in Dec 2004. Last week’s agreed upon reverse merger by Deutsche Telecom for Metro-PCS is a fairly inelegant reworking of DT’s U.S. wireless holdings, but at this point it seems very un-German of them to continue to compete so poorly with AT&T, VZ and even Sprint for that matter.
This morning, Sanford Bernstein analyst Craig Moffett upgraded shares of MetroPCS (PCS) from a Hold to a Buy and raising the price target from $9 to $16 as he feels the stock,
-Shares have settled into a range that suggests deep skepticism about the merger’s ability to deliver planned synergies
-We believe this presents an attractive opportunity. Investors are, in effect, getting two free options. First,there is a free option on a successful merger and the realization of merger synergies. And second, there is the free option that Sprint elects to make a counterbid for MetroPCS”
-We believe the market’s fears that T-Mobile/MetroPCS will be a repeat of the technology integration
morass of Sprint/Nextel reflect a fundamental misunderstanding.
-In fact, there is no technology integration. Instead, there is a very low risk run-off of PCS’s existing
CDMA customer base and a subsequent meshing to two nearly perfectly compatible spectrum portfolios.1
-The probability of successfully achieving synergies appears to us to be significantly higher than is
currently discounted in MetroPCS’s shares.
-The prospect that Sprint might launch a counterbid represents a second “free option.”
-Sprint has repeatedly hinted that a merger with T-Mobile itself was Sprint’s preferred scenario. That now appears off the table. However hard a combination of #3 Sprint and #4 T-Mobile might otherwise have been, a combination after either of the two merges with #5 MetroPCS is all but untenable.
-Sprint, in other words, has few attractive alternatives. They must either bid or stand pat… perhaps permanently.
Basically the analyst is suggesting that at Friday’s close, equity investors are placing a very low probability of a counter-bid by Sprint. But Options traders see it a very different way, on Friday, Oct and Nov premium was being bought hand over fist, with front month implied volatility up nearly 20 points.
SO when an equity analyst describes a stock as a “free option” it may make sense to take a closer look, especially when the activity in the options market is indicating something altogether different. As usual, ignore the options market at your own risk.
Added Reading, the NYT Dealbook blog had a what I thought to be a very useful breakdown of the mechanics of the proposed DT/PCS deal here.