A comparison with other going private transactions:
The market seems to be disagreeing with me regarding American Greetings chances of going private, in that the gap between the stock price and the offered price by the Weiss family has refused to shrink to the levels of other companies being bought out. Let’s look at two of these deals getting a lot of press coverage recently.
The threats to Dell Inc. (NASDAQ:DELL)’s road to going private has been widely publicized. In contrast to American greetings, which is a good 6% or so below the current buyout offer, Dell is currently trading *above* the offered $13.65 per share to shareholders, as the market hopes that minority shareholders will be successful in negotiating better terms for their shares if Dell goes private. This equates to shareholders realizing a potential loss if the deal goes as currently planned. In addition, the group taking American Greetings private have a majority of voting rights, while Dell’s group does not. If Dell’s deal does not go through, I expect deep short term losses to Dell shareholders as the market grapples with the question of the computer manufacturer’s future prospects in a tablet driven market. In contrast, American Greetings’ business is still strong, even if the going private transaction does not occur. Right now, I think American Greetings is the safer risk arbitrage play.
Another buyout offer getting a lot of press is from Berkshire Hathaway Inc. (NYSE:BRK.A)’s acquisition of H.J. Heinz Company (NYSE:HNZ). Heinz currently has a very small gap between stock price and buyout price, around half of a percent or so. This is in spite of some legal action attempting to stop the buyout under its present terms and to take Heinz directors to court. While these legal attempts will probably not bear fruit, Heinz does not look like a sufficiently profitable risk arbitrage play considering the slight risk and time period involved.
The advantages to writing options as opposed to simple stock ownership:
If you want to invest in this risk arbitrage play, consider writing options. The stock is currently trading at around $16.50, which would give you about 6% profit on an investment. But October 2013 put options (at a strike price of 17.5) can currently be written for around $1.6, basically giving you the dividend for the next year up front, which would increase the potential profits from the risk arbitrage play to around 9%-10% of your risked capital. Likewise, if you want to buy stock and write calls, October 17.5 calls can be written for around .30, which adds another 1.5% or so of gains to your risk arbitrage play. If you go the covered call route, you can enjoy the dividend if the deal takes longer than expected, while if you write the puts, you cannot. While the added income these options make is tempting, if the going private offer moves above $17.50 per share due to legal pressure from minority shareholders, you will miss out on those gains.
Cards are boring, but a 5-9% yield in a few months isn’t.
The market as a whole currently looks a bit overpriced to me. This makes arbitrage opportunities like the one offered by American Greetings an excellent market neutral play. American Greetings being successful in their bid to go private is largely independent of the overall market. Due to the undervalued nature of the stock, I don’t see much danger of a giant loss of capital. Either investors make a quick profit, or they are a part owner in an undervalued company with a proven record of cash generation and long history of a dividend. I predict that American Greetings will outperform the S&P 500 over the next three months, and can provide an important hedging function in a portfolio.
The article Buy This Undervalued Company Before It Goes Private originally appeared on Fool.com and is written by Shaun Geer.
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