Arbitrage : Finding Value In The Sprint – T-Mobile Merger

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.