In this economic climate merger investing is a sure way to guaruntee low returns, if not negative returns. Here's why.
Companies rarely have the capitol themselves to complete a notable merger. Those who do (such as if Microsoft were to buy a much smaller company) then the merger would be a good bet, but at the same time, the price of the intended buyout stock would be close to the buyout price because stock investors would have seen that the deal is likely and therefore bought and sold accordingly.
Buyouts which rely on a company taking on debt and/or borrowing capitol to complete the merger is much less likely to be completed in this economic climate because of the credit crunch, or simply, that banks arent lending enough money and if they are, are lending to companies with almost guarunteed chances of remaining solvent and able to repay what they borrowed.
Therefore, when two companies agree that one will take over the other in an "all-cash" deal, or a deal in which the target companies stock will be bought by the other company for an agreed-upon price, than there are many factors which can derail such a merger before it is completed. The more Wall St. thinks that the deal is likely to fall apart, the farther away the stock price is from the "buyout price". this gap in price is called an 'arb spread'. As you can infer, the higher the spread, the less Wall st. thinks the deal will go through.
In the case of Image Entertainment's pending buyout by Nyx Aquisitions, there is an arb spread that is well over 100%. This would normally be a double--hell, even triple red light to most investors who dont like ultra-risk to stay away from DISK. However, there are a couple of reasons that this is an opportunity that looks appealing.
I wont go into the EPS figures or Valuation of the company right now, i am saving that for a future post, this post serves to highlight the risk-reward issue for the merger.
There are two reasons why i am drawn to this pick. The first is because of the fact that the companies, both Nyx and Image are determined to get the deal completed. They believe they need each other and are truly intent on finalizing the merger. There have been numerous extension dates granted to Nyx to come up with the capitol to fund the transaction and each time there has been an investment by Nyx in the amount of millions of dollars into the account which holds the capitol to be paid out in the event the deal is nixed. (if the deal falls apart as a result of one companies actions, the other gets paid money from this account as a compensatory measure. it's not much, but it shows that Nyx believes it can honestly come up with the needed capitol. otherwise they wouldnt just be throwing millions of dollars away). Secondly is the fact that the merger has been agreed to by the shareholders. there is nothing from a shareholder standpoint that can block this merger. The only issue here is capitol to be raised by Nyx.
The one con in this deal is the lack of transparency with regard to just how close nyx is to raising the capitol. it is unclear whether they have 25%, 50% 78% or even 90% of what is needed.
But, i think that the arb spread of over 100% is very appealing on a merger that is more or less a "wait and see on the capitol to be raised" front. That is why i got in on DISK at 1.33.
Make an informed decision on this one. If you want you can wait for my post on the valuations on the stock, but if you're considering an investment in real life, assess how much risk you can accept in this volatile market, and then make a decision.
Happy and safe investing,
$1.3 (04/01/09)
