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About Those EMC Rumors...

By Peter Elstrom Cisco (CSCO) in talks to acquire EMC (EMC)? That was the news report that came out of on July 1. The article on the site, which covers the storage industry for tech professionals, didn't say the megadeal was definitely happening, but it laid out a strong argument for why combining the two companies made some strategic sense.

That article was followed by a Reuters news story the same day that EMC shares had risen 3% in the light trading before the July 4 holiday weekend on rumors of a potential acquisition. The next week, the independent research firm Precursor Group picked up on the reports and gave a thorough analysis about why combining EMC's storage products with Cisco's networking gear "makes a lot of sense."

NOT NEAR AND TOO DEAR. Well, the rumors aren't true. One very well-placed source says the two outfits haven't been discussing an acquisition. This source explained that acquiring EMC would violate two of the key principles for acquisitions that Cisco CEO John Chambers has articulated in public repeatedly.

First, Cisco doesn't do megadeals. (EMC's market cap is $35 billion.) Second, Cisco doesn't acquire companies that are geographically far away because it's difficult to integrate the two groups of employees. (Cisco is headquartered in San Jose, Calif., while EMC is based outside of Boston, in Hopkinton, Mass.)

The two businesses have been cooperating more in recent months -- selling products together, for example -- but that's all. Cisco says it "does not comment on rumors and speculation." An EMC spokesperson also said the company would not comment on the rumors.

STRAIGHTFORWARD MANIPULATION. So how did the reports get started? Check out the trading in EMC options. Volume soared on that Friday, July 1, to nearly 60,000, or six times the normal trading volume. Close to 55,000 calls, which give people the right to buy EMC stock at a fixed price, changed hands. Some traders were placing outsize bets on an increase in EMC's stock price.

At the same time, with most investors on vacation or headed to the beach, trading was so light that EMC shares were pushed up 3.4%, to $14.17. For the most part, the shares continued to rise, closing at $14.48 on Wednesday and dipping slightly to finish at $14.43 on Thursday. What are the chances the options' buyers are the same people who started spreading the word that Cisco could be looking at acquiring the storage giant?

Here's the math behind such motivation. On the morning of Friday, July 1, you could pick up July call options on EMC stock, with a $14 strike price, for 15 cents apiece. So you could get the right to acquire 10,000 shares of EMC stock at $14 each for a total of $1,500, plus commissions. After the rumors of Cisco's interest, the options soared in value, closing at 70 cents each. That would make the same options on 10,000 shares worth $7,000. A quick trader could make nearly five times his money over the course of a few days.

Trouble is, this is the sort of trading strategy that the Securities & Exchange Commission takes a very dim view of. Buying into a position and then spreading rumors to make money is straightforward manipulation. There may be a completely innocent explanation for all this. Still, expect the SEC's enforcement division to start investigating. Elstrom is a senior editor with BusinessWeek in New York

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