Takeover Fever Update

The madness surrounding takeovers continues to dominate option trading. It seems that each time that there is a real bid for a high-profile company (such as Potash (POT) recently), rumors spring up in dozens of stocks. There have been some slight changes in the ways that the rumor and takeover activity are being perceived, but mostly it remains much the same. This is the third time we have addressed this topic this year already, but since the topic is clearly of interest to a broad range of option traders, we will discuss it again.

The previous issues that discussed the topic were Volume 19, No. 5 ("Examining Takeover Rumor Activity") and Volume 19, No. 8 ("Takeovers, Rumors and Strategic Alternatives"). Let’s review some conclusions from those previous articles before getting into the current list of takeover names.

First, let’s define how we determine if a stock is a "takeover rumor." Most of the time, the first clue is elevated levels of call option activity. Second, this activity should be accompanied by an acknowledgment from one of the major news wire services that there is indeed a rumor circulating. These not only include Dow Jones, AP, and Bloomberg, but the "boutique" news services that specialize in tracking this kind of activity.

1) One fact that has held true over the years is that most rumors are false, and traders should ignore them. There are many unscrupulous traders who will circulate a rumor merely for the purpose of unloading an unwanted position to other, unsuspecting traders. This is especially true after a stock has had bad news, if one then sees takeover rumors springing up. Some wire services require independent confirmation of a "story" before it can be run, but I’m not sure all do. So there is always the chance that, if a stock appears as a rumor on one of the "boutique" services, that it has been touted to that service by sellers. Hence, it is not a good idea to trust isolated, single-day rumors, but it is important to keep track of them.

2) However, if a stock has rumor activity on at least three separate occasions within a relatively short period of time, then there is a greater chance that the rumor will actually become a factual takeover bid of some sort.

3) Furthermore, if a company announces that it is pursuing "strategic alternatives," that essentially means that the company is being put up for sale. Of course, that doesn’t mean that the company will always find a buyer, but it is certainly a step in the right direction. Strategic alternatives were often big winners in the last bull market. In the current environment, though, many of the companies that have announced strategic alternatives have not been able to find a buyer – at least not one at the price they want.

4) Most takeover bids are not telegraphed by option activity in advance. Especially, in this litigious age that we live in, companies closely guard their takeover bids, for fear that leaks might prove costly to them in a number of ways – from having to pay a higher price to having to worry about prosecution for insider trading.

Current Activity

The recent rush of takeover activity seems to have been spurred by the bids for Genzyme (GENZ) and Potash. In each case, a bid was made for the company at a substantially higher price, and the lure of gains like that caused traders to pay attention to a lot of other rumors. Table 1 shows the recent activity, with the dates that rumors (including heavy call option activity) took place. Then the recent activity in 3PAR (PAR), where a bidding war has developed) only added to the mania.

Table 1: Recent Takeover Rumors
Stock	Type	Date1	Date2	Date3
AEO	Rumor	08/18/10
AKAM	Rumor	02/25/10	03/10/10	04/23/10	05/17/10	08/20/10
ANR	Rumor	08/17/10
CML	Rumor	08/23/10
CREE	Rumor	08/18/10
CRL	Rumor	08/04/10
EAT	Rumor	08/23/10
FSLR	Rumor	08/04/10
GENZ	Rumor	pre 4/23	07/02/10	07/23/10	07/29/10	08/02/10
HOG	Rumor	pre 4/23	08/05/10
HOLX	Rumor	pre 4/23	07/08/10	08/17/10
HSY	Rumor	08/20/10
ISLN	Rumor	08/23/10
KWK	Rumor	07/19/10	08/18/10
MOS	Rumor	pre 4/23	06/28/10	07/28/10	08/18/10	08/26/10
MRVL	Rumor	08/24/10
NTRS	Rumor	08/11/10	08/12/10	08/16/10
PAR	Rumor	08/23/10	08/24/10	08/25/10
POT	Rumor	08/18/10	08/19/10	08/20/10
RHT	Rumor	08/23/10
SHLD	Rumor	08/17/10
SONS	Rumor	08/10/10
STI	Rumor	07/07/10	08/18/10
TEX	Rumor	08/20/10	08/23/10
WBSN	Rumor	08/20/10
WCG	Rumor	08/23/10
X	Rumor	08/18/10

Table 1 above shows the recent rumor activity. The ones that are highlighted in green are the ones that have recently appeared at least three times within a short period of time. The three stocks mentioned above are included, as are Mosaic (MOS) and Northern Trust (NTRS). By "rule" 2) above, those would be the only ones in Table 1 worth consideration.

Recent Actual Takeover Bids here.

However, Table 1 is not a complete list of the takeover activity that has been taking place. Another way is to look at actual takeover bids that were made and see if there was heavy option activity. A fairly easy way to do this – at least for optionable stocks – is to visit the OCC’s Contract Adjustments page:

Merely going back over the 100 most recent memos, we find these takeovers that were not preceded by unusual option activity (i.e., we wouldn’t have been able to find these on any rumor or high activity list).

Table 2: Recent"Unadvertised" Takeover Bids
ACCL*	CYBS	IWA	SMTS
ADCT	DBTK*	ODSY	SNWL*
AIPC	DCP	PFWD	SY
ATSI*	GNA	Q*	UBET*
AYE	HGRD*	SCE	WBMD
BELM*	HTX*	SMMX*	WSII
CRN	IUSA*

Those stocks marked with an asterisk (*) are ones that are selling for less than $10 – typically ones that we would not buy, even if there were a rumored takeover. In any case, we would not have participated in these because there was no advance warning.

However, there was another group that did have option activity in advance of a recent takeover bid. Table 3 shows the list of completed takeovers in this category, along with a brief comment on each.

Here are the keys to the table:

SA:

2nd stage:

The gain/loss commentary refers to the stock price, not any option purchase

(Parens): the number in parens is the time, in months, from the first option activity until the eventual takeover bid was received a bid was received (and there was no option activity on that first bid), and then option activity was heavy and ongoing.

If you had waited until "strategic alternatives" were announced, or until at least one initial actual bid was made (or both), and then bought the stock, you would have had a gain in most of the cases in Table 3.

Some would have been impossible to spot (ECLP and STST, in particular, since the only "clues" were unsubstantiated rumor activity on one day – a situation we’ve already warned to avoid).

Professional risk arbs probably made money in most of these situations, whereas retail investors probably lost money. Why? Because in order to profit, it was likely necessary to buy stock and carry it, rather than to buy options. The lengthy times and modest gains would have meant a good deal of loss in terms of time value premium to option traders. The only way to effectively combat the option time decay would have been to buy deeply in-the-money calls with little or no time value. Alternatively, one could buy calls and sell puts, but that is effectively the same as buying stock.

I suppose one could merely sell puts, figuring that a series of short-term put sales over a few months would add up to about the same profit as the stock in many of the cases in Table 3. The problem there, though, is that the larger stock gains would not be matched, and the downside risk is large if the deal falls apart altogether. There have not been any major blown deals lately, but there are always a few, and put sellers bear the full brunt of the losses in such situations.

In any case, one trait that many of the stocks in Table 3 have in common is that a real bid was made, and then the stock could be bought for gains when a higher (perhaps, competing) bid was received.

The next set of data, shown in Table 4, are those situations that are currently still ongoing, where a first bid has been received, but rumors are rampant that higher bids are in the works.

In each case, the stock is trading higher than the received bid, and there have multiple cases of rumor activity along the way. Note that three of these are the same stocks that were highlighted in Table 1 – GENZ, PAR, and POT.

Finally, what about "strategic alternatives?" There were a few in Table 3, but what about the others? It turns out that the strategy of buying stocks that announce they are exploring strategic alternatives hasn’t been as successful in recent months. In some cases, I’m sure that the companies seeking buyers were asking too much. But there’s also the problem of the current economic environment. While it’s true that some companies are willing to spend their cash in certain places, it appears that there aren’t nearly as many willing to do so as there were, say, three years ago. Hence, merely announcing "strategic alternatives" is not necessarily the magic elixir that it once was.

That’s not a particularly appealing list of result in Table 5. MIL and RISK were earlier this year. In recent months, there hasn’t been on`e decent gain from this strategy.

So, it’s a sign of the times that even this formerly reliable strategy of buying stocks that announce that they are exploring "strategic alternatives" isn’t working well in the current environment. Rather, it seems, that the only thing that is working with respect to takeovers is to concentrate on situations where a valid bid has already been received, and there are prospects that a higher bid could be made.

In summary, of all the stocks listed in these tables, it is the five green-highlighted stocks in Table 1 that appear to be the most viable. Furthermore, since NTRS and MOS have not yet received takeover bids, that leaves the other three: GENZ, PAR, and POT.

I’m not sure how much upside there is in each of these, as their stories are quite well-known, and the stocks are each trading well above the bid they have already received. However, there are relatively expensive puts in each case, and thus the sale of puts or put credit spreads might be a reasonable approach.

Table 4: Ongoing "Advertised" Bids
DYN	BX bid $4.50; rumor: private equity bid
GENZ	SNY bid $69; rumors of higher bid
NOVL	$5.75 bid; SA;
PAR	DELL: 16; HPQ: 24; DELL 24.3; HPQ 27
POT	BHP $130; rumor of raise to $150

Table 5: Strategic Alternatives
ARD	no gain (1)
ASCA	ongoing since 8/11/10
BKS	ongoing since 8/03/10
CASY	SA led to self tender; loss (4)
CPKI	ongoing since 4/12/10; not promising
FIS	SA led to Dutch auction; loss (3)
ID	ongoing since 3/01/10; still viable
IDC	decent gain (4)
MIL	large gain (1)
OSIP	no gain (2)
PALM	small gain (1)
PLCM	ongoing since 4/14/10; no buyers found
REXI	ongoing since 7/27/10
RGS	ongoing since 8/04/10
RISK	strong gain (2)
RSH	ongoing since March; not promising

Announced strategic alternatives

Table 3: Recent "Advertised Takeovers
ARD	SA, but no gain (1)
ARG	2nd stage; small gain (6)
CASY	2nd stage; SA; self tender; LOSS (4)
CKR	3rd stage, at very end; small gain (1)
DTG	2nd stage; small gain (4)
ECLP	1 day rumor a week before (0)
FIS	2nd stage; rejected bid; SA; LOSS (3)
IDC	SA; decent gain (4)
LGF	2nd/ 3rd stage; small gain (3)
LIHR	2nd stage; small gain (4)
MIL	2nd stage; SA: large gain (1)
OSIP	2nd stage; SA; no gain (2)
OSTE	SA Aug 3rd; bid Aug 17th; strong gain (0)
PSYS	2nd stage; modest gain (2)
PTV	series of rumors; modest gain (3)
RISK	SA; strong gain (2)
SII	2nd stage, but only one day to get in (0)
STST	1 day rumor two months before
VTIV	acknowledged bids; modest gain (3)

Disclosure: We have put credit spreads in POT and GENZ.