Merger Speculators Take $20 Billion Bath as Deals UnravelCallie Bost, Joseph Ciolli and Tara Lachapelle
For traders trying to profit from takeovers, Aug. 5, 2014, is a day that will live in infamy.
More than $20 billion has been erased from the market value of Time Warner Inc., Sprint Corp., T-Mobile US Inc. and Walgreen Co. the day after two proposed mergers unraveled and the tax treatment of a third was reassessed. Equity options tied to the deals that had exploded in popularity were squashed.
After volatility reached a seven-year low and the Dow Jones Industrial Average traded little changed for 2014, takeovers have been one of the few sources of action in the U.S. stock market. Walgreen and Time Warner posted two of the three biggest declines in the Standard & Poor’s 500 Index today, with both falling more than 10 percent.
“If you want to dabble with fire, you sometimes get burned,” Robert Pavlik, who helps oversee $4.5 billion as chief market strategist at Banyan Partners LLC in New York, said in a phone interview. “If you’re an investor trying to make money doing merger arbitrage, this is the risk you run.”
21st Century Fox Inc. withdrew its unsolicited takeover offer of $75 billion for Time Warner. Rupert Murdoch, the billionaire chairman of Fox, said he’s backing down after Time Warner’s board refused to engage in talks and Fox’s stock price declined since the offer became public.
Fox, which instead authorized a $6 billion stock repurchase yesterday, rose 3.8 percent to $32.21 as of 12:06 p.m. in New York. Time Warner plunged 12 percent, the biggest drop since 2008, to $74.86.
“Once the deals start to fall apart, it gives everyone pause about the next deals,” Tim Biggam, chief options strategist at TradingBlock, a brokerage firm at the Chicago Board Options Exchange, said by phone. “Some of the underpinnings of stock valuations have been reconsidered.”
Sprint ended talks to acquire T-Mobile, a person with knowledge of the matter said, as regulatory concerns outweighed the potential benefits. The decision caps a nine-month effort by Japanese billionaire Masayoshi Son, whose SoftBank Corp. controls Sprint, to create a rival to Verizon Communications Inc. and AT&T Inc.
Shares of Sprint tumbled 18 percent to $5.89. T-Mobile sank 6.3 percent to $31.78.
Walgreen, the biggest U.S. drugstore chain, said it plans to pay about $15.3 billion for the part of Alliance Boots it doesn’t already own, and won’t use the deal to move its tax address abroad. The company had considered redomiciling in Switzerland to lower its tax rate and has come under political pressure not to do a so-called tax inversion. The stock lost 12 percent to $60.69 for the largest drop since 2007.
“Yesterday and today will be one of the more difficult periods for event-driven traders and portfolio managers in recent memory,” Keith Moore, an analyst at MKM Partners LLC in Stamford, Connecticut, wrote in a note to clients this morning. “Given that spreads and returns in the area have generally been difficult to generate, these developments are particularly painful.”
Options that were poised to profit had the mergers closed were in freefall. In Time Warner, bullish calls that paid should the stock reach $85 by Aug. 16 dropped to 1 cent from $1.65 yesterday.
Open interest in the contract, a measure of the number of positions that have been created, increased from 18 contracts before market open on July 16 to about 17,000.
Other Time Warner options that tumbled today include $84 and $85 contracts that expire in two days. The prices for both fell 99 percent. The five most-owned Time Warner calls, all expiring in August or October, fell more than 80 percent.
“Ouch!” Andrew Wilkinson, chief market analyst at Interactive Brokers LLC, said in a research note today. Fox abandoning its bid for Time Warner “is not what event-driven call buyers wanted to hear having locked-in to bullish bets,” he wrote.
Puts on Time Warner shares expiring in 10 days with a strike price of $72.50 were the most-active contract. The price jumped to 52 cents from 3 cents yesterday.
Bullish Sprint options were also crushed. The cost of $8 calls expiring Aug. 16, the contract with the highest ownership, dropped to 1 cent. It traded at 90 cents at the beginning of July. Open interest was about 109,000 contracts yesterday, from 3,600 at the end of April.
Bearish wagers with a $6 strike price expiring Sept. 20 were the most-traded Sprint contract today. The price rose to 51 cents from 10 cents.
Money managers tracked by the Hedge Fund Research HFRX Event-Driven Index are up 3.4 percent this year, trailing the S&P 500’s 4.9 percent gain. The gauge rose about 14 percent in 2013, a year when the S&P 500 rallied 30 percent for its best year since the 1990s. The firm’s merger arbitrage index has climbed 0.3 percent in 2014.
“The thing that we’re taking away from this whole trend in M&A is to take a step back,” Tim Hartzell, who helps oversee $500 million as chief investment officer for Houston-based Sequent Asset Management LLC, said in a phone interview.
“One headline is about who’s buying who, billions of dollars, valuations and isn’t this exciting,” he said. “But, the news item two steps down, is about the billions of dollars the banks are spending for all the M&A activity they did in 2008 and 2009. If you can’t learn from history repeating itself, why would you get excited and buy into all the hype?”