Why Investing In “Sure Thing” Buyouts Is Risky

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Usually when one company offers to buy another company, it offers a premium on the current stock price and the stock price jumps up pretty close to the offered price. The difference in the current price and the buyout price, that “pretty close” number, includes a variety of factors. Those factors include the risk that the deal won’t be approved by regulators or shareholders, the time value of money (a deal that will close tomorrow has less of a discount versus a deal to close in a year), or a whole host of other factors. The shareholders that held the stock before wind of this pending offer are generally happy since their shares will appreciate more than they expected. Some investors consider buying the stock because there still is a little bit of difference between the current share price and the offered price. It seems like a sure thing right? Wrong.

When Bank of America offered to buy Countrywide Financial, it offered absolutely no premium. It offered $7.16 a share on January 11th. Shares of Countrywide are only trading at $4.27 right now… why not snap up shares of CFC at $4.27 and pick up what appears to be a nice healthy premium for your money? You might not want to do that because Countrywide is going to be investigated by the FBI. Woah! That wasn’t in the list of “factors” I listed above and that’s because it’s not something you typically associate with a buy out! If the FBI finds something bad, Bank of America can still back out.

As Ron Popeil would say, but wait there’s more… let’s say you heard about the Microsoft offer of cash and stock for Yahoo, pricing each share at around $31. Let’s say you decided to snatch up a few shares of Yahoo on the buy-out offer because you wanted to make a few bucks and because you thought the buy-out made sense. Then Yahoo tried to find additional suitors to increase the sale price only to find out no one else was truly interested. In the interim, Yahoo and Microsoft stock prices fell so the original offer wasn’t as high, a scenario not mentioned in the list. The underlying offer, since it was pegged to an asset whose value changed, changed as time passed!

So, if you hear of a buy-out and are considering to snatch up some “sure thing” money, think twice. There are a lot of factors and scenarios out there that you may not be taking into account. The market has figured it out and that’s why there’s a difference in the first place. 🙂

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One Response to “Why Investing In “Sure Thing” Buyouts Is Risky”

  1. Adfecto says:

    Buyout situations like this are very rarely worth the transaction costs to pay the game. There are professional Wall Street bankers that spend their whole day doing nothing but analyzing buyouts. This technique even has a special name called “merger arbitrage” with funds and bankers that specialize in it.

    Leave this game to the big guys because I promise you they have already squeezed the deal for all the profit well before you put your money in the ring. I don’t believe in a perfectly efficient market but in these deals the big players have almost always priced in all available information and that leaves you with nothing more than coin flip odds to get it right and very little return for your risk.

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