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One of the great things about the stock market is the occasional inefficiency that creates opportunity for savvy investors.
Case in point: After delivering terrible earnings three months ago, Conn’s Inc. (NASDAQ: CONN) fell to $26 a share. It has since risen to $36 on speculation of a buyout.
Conn’s hasty recovery seemed quite unlikely. I figured the company would report another terrible quarter on Tuesday, so I purchased puts. Turns out I was right, but only because the market was incredibly inefficient in its assessment of Conn’s.
I also think the market has it wrong on the DIRECTV (NYSE: DTV) merger with AT&T (NYSE: T). AT&T’s buyout price for DTV was $95 per share. The stock presently trades at $83.57, and has never gone above $89.46 since the merger was announced.
What’s the problem? The market is pricing in the possibility that the DIRECTV merger will fail.
There are two hurdles to the merger going through. The first has already been taken care of. The deal was contingent on DTV renewing its NFL Sunday Ticket package with the NFL. That deal has already been struck.
The other concern is it will be blocked by the federal government. This concern is overblown for many reasons.
First, there’s no legitimate reason to block the merger. While the merger creates synergies for the two companies, it isn’t anti-competitive. AT&T is not a content provider or distributor, as DTV is. Nor is DTV a phone or broadband provider. The merger, in fact, allows for a more efficient bundling of services than presently exists.
Second, the feds rarely block mergers. The ones it has blocked made some sense at the time.
United Airlines (NYSE: UAL) was blocked from merging with US Air in 2001, only to have the latter merge with American Airlines (NYSE: AAL) last year. Oracle (NASDAQ: ORCL) was prevented from marrying PeopleSoft, sued, and won in 2004. The Nasdaq-NYSE Euronext buyout was blocked by the DOJ. EchoStar (NASDAQ: SATS) was actually blocked from buying DIRECTV in 2002.
So what we have is a market that seems to think the federal government is going to shoot down this merger, and that creates opportunity. Warren Buffett apparently thinks it’s all going to work out because he ADDED to his holdings of DIRECTV in the third quarter.
If you agree with Buffett, you could just buy DIRECTV stock right here and wait it out. The merger is supposed to close in the spring. That would mean an $11.43 profit on an $83.57 investment, or a 13.7% return. You could do a lot worse!
If you want to hedge your bets, you can try a strategy I’ve already employed. Back in August, I sold the DTV December $85 Puts for about $4. That means that between then and Dec. 20, the holder of those puts could force me to buy shares of DTV at $85. Fine by me! I’ll gladly take those shares. In fact, I’m so glad that I sold the March $85 Puts for about the same price.
If the shares are put to me, I get them at an effective price of $81, factoring in the $4 premium I received. That enhances my return if the merger goes through.
But even if the merger is blocked, I am still happy to own shares of DIRECTV. It’s a great business on its own, with $4.9 billion in cash and long-term investments that has generated $3.2 billion in free cash flow over the trailing 12 months.
Heck, if Warren Buffett wants the stock, who am I to doubt him?
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