MorningWord 7/10/13: Yesterday, FDX saw some curious action, opening up nearly 1% and seemingly skipping higher 1% every half hour till the stock topped out in the early afternoon, up 7.5% at one point.
To put the move in context , the stock has not risen by that much in a single day since following an earnings even back in December 2011, and the stock had its biggest volume day in more than 5 years. Near the height of the giddy stock action shortly after 11am (stock was trading $105.84), a trader bought 10,000 of the August 120 calls for .50 to open. Someone paid $500,000 in premium for the right to own the stock at $120 in a little less than 40 days, a period that will not catch an earnings event.
As you would expect short dated implied volatility saw a considerable spike up more than 10 points.
So why all the excitement you may ask? On Monday it was reported in the press that Bill Ackman who runs Pershing Square Capital in a letter to investors that they were raising money for a specific fund to buy the stock of a large U.S. company. The description of unnamed company, as reported in a Bernstein Research note to clients yesterday:
Simple, predictable, free cash flow generative and as enjoying high barriers to entry, high customer switching costs, and substantial pricing power. Trading at a discount to its closest competitor.
Obviously many investors didn’t wait to hear what exactly the special purpose fund was going to be buying and rushed into FDX shares. The fever broke shortly after midday when other names such as ADT surfaced as potential candidates that fit the above description.
In Bernstein’s note, analyst David Vernon suggests, in response to client questions:
FDX does indeed have some pricing power in domestic services (less so in international), enjoys high barriers to entry (again in domestic services), is free cash flow generative, and is trading at a discount to UPS.
We would not agree that the business is simple or predictable. While it is true that the business of transportation is fairly straightforward – pick it up, move it, set it down – there is a fair degree of complexity involved managing multi modal network operations particularly ones that involve a large airline
We would also not agree that customers have high switching costs. While there are some locations where UPS or FDX have a geographic advantage making it difficult to switch .
On the activist front, if FDX was in Ackman’s sights, Bernstein (who rates FDX share Hold with a $102 target) “sees a wide range of potential actions that can be taken that might accelerate a transition to a more sustainable business and re-position the company’s services to better match demand trends”.
We will obviously know soon enough, but let’s not forget that trying to mask the performance of a very deep pocket investor like Ackman can be a difficult proposition as he is not looking to make a quick buck and guys like him usually have something that guys like us don’t have – time and patience.
The speculation yesterday really doesn’t change much as it relates to our near-term bearish position (long Aug 100/95/90 Put Fly read here). As we discussed yesterday, we might look to close out the short 95 put if the value declines to below $0.35, particularly if it gets there because implied vol moves back down rather than by the stock moving higher.