Last night on CNBC’s Fast Money we had a brief discussion of the Pfizer Allergen merger agreement announced earlier that day. While there is little overlap in products, lots of cross selling and cost cutting opportunities, or “synergies”, the proposed deal that will face no shortage of opposition, is about Pfizer paying lower taxes in AGN’s headquarter’s domicile, Ireland (15% vs PFE’s current 25% in the U.S.). The proposal has already become a political pinata, with a few presidential candidates, from both sides weighing in with some fairly tough rhetoric against such deals. Our conversation on the program quickly turned to other potential tax inversion candidates, watch here:
Here were my notes for the segment:
ARMH – UK, $23 billion market cap, maybe AAPL, been floated before, they design most of AAPL pc chips, but don’t manufacture them, QCOM or TXN, also customers.
SAP – Germany, $97 billion market cap, maybe ORCL?
GRMN – Switzerland – $7 billion market cap, maybe a TXN or QCOM.
NXPI – Netherlands, currently in deal to buy Fresscale, NXPI $20 billion market cap, prob tough to do.
Of all the names listed above, ARMH could be the most likely take-over candidate. First and foremost, because there seems to be an insatiable need for semiconductor companies to merge this year, with close to $100 billion in deals already announced this year:
-Avago (AVGO) for Broadcom (BRCM) – $37 billion
-Western Digital (WDC) for Sandisk (SNDK) – $19 billion
-Intel (INTC) for Altera (ALTR) – $17 billion
-NXP (NXPI) for FreeScale (FSL) – $16.7 billion
-Lam Research (LRCX) for Kla Tencor (KLAC) – $10.6 billion
-Microsemi (MSCC) for PMC Sierra (PMCS) – $2.5 billion
So who could buy ARMH and Why? Let me take a shot at a couple scenarios that make a lot of sense:
While ARMH does not have any manufacturing capabilities, they do receive licensing fees for their designs. And as AAPL is moving to a greater reliance on their own chip designs, which leverage ARMH’s intellectual property, this is a deal that could make sense when you consider just how much tax AAPL has amassed overseas, nearly 85% of their existing $205 billion cash hoard. Not that a deal and a lower tax rate would have any affect on that cash pile, but the company is generating a ton of cash overseas each quarter and without some sort of amnesty the company will need to continue to tap the debt markets to meet their cash return obligations. ARMH’s 16.5% tax rate so far in 2015 could be a lot more attractive on AAPL’s expected fiscal 2016 sales of $245 billion and operating profit of $73 billion on an expected rate north of 25%. The headlines surrounding an announcement like this would be massive as AAPL is massive. It would be the biggest shot across the bow of US corporate tax structuring and would be on the front page of every newspaper in the country, let along the world. This makes the scenario unlikely, but it is interesting to consider.
Possibly more likely as a potential acquirer would be Qualcomm (QCOM) which is also fab-less, like ARMH, and relies on licensing fees for their designs. Per Bloomberg; “Qualcomm gets about 60 percent of its operating income from licensing its mobile technology”. With QCOM, the issue is less tax payments, as the company has paid less than 20% for the last five years, but the potential need for growth, which ARMH has with 15% expected earnings and sales growth in 2016. QCOM is down 33% on the year, down 40% from its all time highs made last year, trading at 4 year lows, and has a pile of cash ($31 billion, $20 billion net of debt) burning a whole in its balance sheet, on a $74 billion market cap. Activist investors are present in QCOM and they have pushed for increased capital return to a corporate split, maybe an all of the above with an inversion deal would do the trick?
So how do you trade ARMH if you think they could be the next mega-semi target? Options open interest in the adr is not fantastic, with a total of 38,000 options, so they kind of trade by appointment, but we will take a stab.
So What’s The Trade?
Trade Idea – ARMH ($48.88) Buy the April 42 / 55 risk reversal for .20
-Sell to open 1 April 42 put at 1.20
-Buy to open 1 April 55 call for 1.40
Breakeven on April expiration:
-Losses like stock below $42.20.
-Gains like stock above 55.20. Loss of .20 between 42 and 55.
Rationale – This trade provides unlimited upside above $55.20 if there is a takeover/ inversion but provides some room to the downside because it’s not exactly a no brainer entry on the stock if there is no news. There is risk below 42 so one must be willing to own the stock at that level.
This is a trade we are considering, but will be doing more work on the stock, as it is not one we know well, but wanted to offer an options structure as an alternative for those who might consider buying stock.