Sprint – T-Mobile Merger
Is it
time to jump on the Arbitrage train with the Sprint – T-Mobile merger? With the
current market prices (as of 11-28-18 pre-market) sitting at $6.18 and $67.49
respectively, there is an 11.39% upside in this deal (12% when fractional
shares are paid out in cash).
There is
always risk associated with mergers and acquisition, but if an investor waits
until there is more clarity and certainty, the gains made can become a good
source of passive income. The recent mergers between Rockwell Collins (COL) and
United Technologies (UTX) have proven that getting in at the right moment can
be very lucrative for an investor.
Due to
the beat-down of stocks in October, COL had dropped to $131 and change on a
$140 per share merger valuation. An investor buying at the $131 price gained
over $8 per share recently when the final approval was received from China and
the COL shot up to over $141 per share, which was higher than the merger
valuation.
Another
similar merger is taking place right now with SCANA Corp. (SCG) and Dominion
(D) where, recognizing the depressed stock price of SCG in October, an investor
could have purchased shares of SCG for $36 and change on a $56 per share merger
valuation.
Now one
must ask the question “Is the T-Mobile / Sprint merger worth entering?” The
terms of the all-stock transaction state that for every one share of Sprint
held, the investor will receive 0.1026 of a share of T-Mobile. So long as the
stock price of T-Mobile remains 10x the stock price of Sprint, there will be a
10% upside to the buy. If that gap widens, the arbitrage realized could be
greater than 12%.
If
Albert Einstein is correct that “Compound interest is the eighth wonder of the
world,” then arbitrage is the ninth! ...and you can quote me on that. In a
recent post I wrote about the options presented to investors concerning this
merger (https://www.linkedin.com/pulse/t-mobile-sprint-merger-unlock-value-ken-rupert/). Now that this merger is
beginning to show some steam, I think it is time for investors to consider the
upside potential.
With the
T-Mobile / Sprint merger could close faster than expected. Although the target
for closing the deal is Q2-19, it is possible that the timeline for closure
could be accelerated to Q1-19. The last hurdle are depositions with the DOJ,
which are expected to be complete in mid-December. With that timeline, it is
more likely to close in Q2 but if final approvals are received quicker, Q1
might be realistic.
Before
the deal can be finalized, it will have to be approved by the Justice
Department, which will review it for antitrust violations. Mark my words, on
the day that the DOJ grants approval, there will be a seismic shift in stock
prices. In the case of COL-UTX merger, when the final approval was received
from China, COL shot up to the merger valuation and more. Announcements of
final approval are equivalent to an adrenaline shot for a tired body.
So when
should an Investor make the move to purchase Sprint? Again, so long as the
stock price of T-Mobile remains 10x that of Sprint, there is money to be made.
If that spread shrinks, the opportunity will begin dry up. Of course, once an
investor purchases Sprint shares, the spread must remain for the arbitrage to
remain intact.
It is
important to understand that there are three ways for the spread to shrink. The
first being that the share price of Sprint increase and the share price of
T-Mobile stagnates. The second is the share price of T-Mobile decreases and the
share price of Sprint stagnates. The worst case scenario is that Sprint’s share
price increases and T-Mobile’s share price decreases (unless at that time, an
investor is holding Sprint stock, which can be sold on the spread shrinkage
given the third scenario).
An arbitrageur
is trying to capture the spread between the trading price of a stock and the
true value of that stock. In the case of mergers and acquisitions, that spread
is between the trading price and the merger valuation (the price being paid for
the Acquiree).
I spend
countless hours studying mergers and acquisitions, analyzing the spreads,
monitoring the approval process, and calculating the timing. Taking advantage
of the arbitrage created by these corporate actions is as much of an art as it
is technical analysis. However, I have a few rules I follow as new mergers and
acquisitions are announced:
First,
buying on rumors creates too much risk: You have to keep in mind that mergers
and acquisitions can take up to 24 months to close (something I will touch on
later). There are so many adverse developments that can shut down M&A
activity. A geo-political event, foreign regulators, or an economic down-turn.
I never buy on the rumor.
Next,
give the merger or acquisition time to settle out after it has been announced. Typically,
when a merger is announced, the market reacts in one or two ways. If the market
likes the merger, the acquiree’s stock will spike to near the merger valuation.
If the market does not like the merger, the acquirer’s stock will drop precipitously.
I never buy into a merger or acquisition on the announcement.
Finally,
wait for an appropriate opportunity to open a position in the Acquiree. As the
merger or acquisition goes through the process of attaining approvals from the
boards, shareholders, and the government, the market continues to respond to
economic news, geo-political events, and other market drivers.
That is
what happened in October and the beginning of November. That is why COL dropped
to $131 and change leaving a double-digit arbitrage play. The same thing has
happened to the SCG – D acquisition. And now it looks like the Sprint and
T-Mobile merger is in the same position. Investors have undervalued Sprint and
as T-Mobile’s stock price continues to inch up, the arbitrage play is growing.
When a
merger or acquisition is announced, it usually requires multiple approvals and
at least 18 to 24 months of transition before the deal closes. The early days
of a merger or acquisition can make a stock bounce, but eventually it settles
back down and thus begins the clock on arbitrage. I have a time target in which
I will open a position in a merger or acquisition.
Is the
time right for an investor to open a position in Sprint? I do not know about
you, but for this investor, based on the rules, the Sprint / T-Mobile merger is
near the sweet spot.
Arbitrage.
I don’t know… I just like saying that word.
