We wanted to take this opportunity to message members about a potential arbitrage opportunity. First, let’s quickly go over what this means.
Arbitrage is a trading strategy in which an investor takes advantage of a potential price differential.
It usually occurs in the event of takeover announcements. In these cases, an arbitrage opportunity exists when the company being acquired is trading at a discount to the takeover price. Why would a company trade at a discount? The reasons are many but are usually tied to the likelihood of the deal closing.
For example, if it is unlikely that regulators would approve the deal, then that risk is baked into the share price. The higher the risk, the bigger the gap. Time is another factor. Usually, the further out the closing date, the bigger the gap as there is more risk of something happening within that time frame to nix the deal.
All this being said, arbitrage opportunities can be very attractive which brings us to the reason for this email. Yesterday in our Discord, one of our members highlighted the current price gap between Activision’s (ATVI) market price and Microsoft’s takeover price.
A few weeks ago, Microsoft announced plans to acquire Activision in an all-cash deal at $95.00 per share. This means that if you are a shareholder of Activision when the deal officially closes, you’ll be paid $95 USD a share in cash.
Today Activision is only trading at $79.09 per share, which implies 20.2% upside, assuming the deal closes.
After doing some research we didn’t find any reason for this gap to exist, outside of perhaps the time between the announcement and expected close (2023). Thus far, there has been no indication that regulators would step in and nix the deal and with a pretty heft breakup fee of $3 billion, Activision should be motivated to get this deal done.
Given this, it is likely that both Dan and I will be taking a short-term position in Activision. Outside of the attractive arbitrage, Activision is actually trading at pretty cheap valuations. The company was mired in some cultural issues with complaints of harassment and the share price has taken a hit.
It is trading at a discount to its 52-week high of $104.53 per share and at a 30% discount to historical averages. It has a reasonable forward P/E of 17 as analysts expect strong EPS growth in the mid-to-high teens over the next 3 to 5 years.
Why is this important? Because if the Microsoft deal falls through, we have to be comfortable holding the underlying company itself.
Typically, if a deal collapses then the company being acquired will return to trade around pre-acquisition announcement levels. In this case, that is around $67 per share.
In our opinion, should the deal fall through it is unlikely to fall that low and even if it does, it is likely to rebound fairly quickly given the cheap valuations.
All things considered, make no mistake this is a trading strategy and not an investment strategy. The thesis here is relatively simple. Investors buy Activision now, and when the deal closes, which is expected to be sometime in 2023, investors would realize a 20.8% gain.
It is important for members to understand that this type of strategy is not without risk though. Yes, the acquisition could go smoothly and ultimately if you bought Activision today and simply waited until the deal closed, you’d earn a 20.8% return.
But, there are also situations where the deal hits roadblocks or gets nixed, and that would no doubt impact Activision’s share price. Arbitrage opportunities do not exist without reason, and the market seems to think that this deal ultimately won’t go through. But, this risk is reduced somewhat as if the deal falls through, Mat and I would be comfortable simply holding Activision.
As always, please ensure you do your own due diligence before making any trading or investment decision, weigh the risk/reward potential, and see if it’s right for you.
Also, given the risk and time sensitivity of this trade, one should be monitoring all news coming from both these companies and be ready to act in the event that a material event changes the landscape for the trade.
Finally, credit to our member who goes by the moniker RobA in our Discord for being the first to bring this to our attention.
Maybe we’ll use this as an opportunity to remind everyone who isn’t already to join our Discord server. You can watch a video here on how to join and set up alerts.
