LA CASA HINCHABLE, EL VICTORIA

A move that could certainly be considered counterintuitive and classically contrarian would be to buy the stock of a company that is threatened or hit by industrial action. In late 2006, the United Steelworkers Union threatened Goodyear Tire & Rubber Co. (GT) with strikes in a dispute over planned plant closings. As strike calls mounted and then took effect October 5 at 16 plants in the United States and Canada, Goodyear’s share price came under pressure and the uncertainty of the situation led to extreme share price volatility. We bought and sold Goodyear stock eight times during the week the strike was called with the stock price fluctuating around $14 and change. Price weakness lasted just a couple of weeks into the three month strike, however, as it became clear that the company was well pre-pared to weather a prolonged bout of industrial action. For most of the time that the strike was actually taking place, Goodyear’s stock rallied and continued to do so after the dispute was settled in early January, touch-ing $25 on January 9, 2007, before falltouch-ing back at the end of February to $24.62.

ACQUISITIONS

Another common cause of a sudden drop in a stock’s price that can repre-sent a buying opportunity occurs following the announcement by a com-pany of a planned acquisition. Typically, when one comcom-pany announces its intention to acquire another company, the stock of the acquiring company drops regardless of whether the acquisition is done on a friendly or a hos-tile basis. There are several reasons for this phenomenon. The acquiring company more often than not needs to pay a premium to the target’s cur-rent market price to secure the purchase. Moreover, the acquisition can often be expected to dilute the acquirer’s earnings, at least over the short term and often increase net debt, making the company more highly lever-aged. Also, there is always some element of doubt that the acquisition can be made to work in terms of post-merger integration of the two compa-nies. There is a risk of potential management distraction as well as a fear that on a long-term view the acquirer may have over-valued its prize and is overpaying. Finally, there is the simple statistical fact that many if not most mergers and acquisitions do not add value over time.

From the viewpoint of the shareholders in the company being ac-quired, however, the news is normally nothing but positive. The acquiring company buys out the stockholders at a premium price over what the stock was trading for preannouncement. There is also the possible additional up-side should the company now become “in play” and spark a bidding war between several suitors. (See the story of the Johnson & Johnson/Boston Scientific/Guidant saga in Chapter 6 as an illustration of this.)

For a trader seeking ripple price fluctuations, acquisitions provide two opportunities for profit. The first is by using acquisition arbitrage. The sec-ond is by taking advantage of the typical drop in price that affects an ac-quiring company as it announces its move.

Arbitrage involves the profitable exploitation of price disparities be-tween two markets, but in a merger/acquisition situation, various kinds of arbitrage opportunity can be opened up when one company bids for an-other. In a hostile takeover, arbitrageurs can take a position betting that a bid will have to be raised to ensure the snaring of the target, or that a bidding war may ensue, now that the target is seen to be “in play.” This can be risky because the bid may be called off with the result that the so-called bid premium will disappear, driving the target company’s stock price back to where it was before the bid was first made, a losing proposition for the arbitrageur.

A situation more to our liking is where a bid is agreed upon at a certain price, but for regulatory or other reasons the deal can only be completed at a later date, often several months later. The element of doubt in investors’

minds—that the deal will, in fact, successfully close—means that the stock

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of the target company typically trades at a discount to the agreed acqui-sition price. Later, as the date of the deal’s closing nears, the price trends upwards towards the agreed price. There is risk here, too, that the deal may ultimately fall through. That is why the price disparity exists. But in an agreed bid the risk is less than it is when the bid is hostile or contested, and in many cases can be well worth the risk. It is worthwhile taking a look at one example of this from our own trading record, involving special-ist credit card issuer MBNA Corp.

MBNA Corp.

We first bought 200 shares of MBNA Corp. (stock symbol at that time KRB) rather fortuitously for $21.58 on June 16, 2005, just two weeks before Bank of America agreed to buy MBNA in a $35 billion cash and stock deal. How-ever, the deal was set to complete only by January 1, 2006, after all nec-essary approvals from each company’s shareholders as well as regulatory green lights had been obtained. On the day the bid was announced, June 30, 2005, we sold our 200 shares for $26.60, netting a profit of $993. Never-theless, following the pop that came with the merger announcement, the stock price fell back later that day as further consideration was given to the possibility of the deal not receiving its necessary regulatory approvals.

There were also fears that Bank of America’s stock price could dip un-der the pressure of the acquisition, thus lessening the theoretical value of the deal owing to its stock component—something which did indeed oc-cur over the next few months. As MBNA’s stock retreated on June 30, we bought back our 200 shares at $26.33 and on the following day, July 1, we bought an additional 200 MBNA shares at $25.74. These last were sold on July 13 at $26.04, but bought back again July 19 for $25.74. The stock price remained under pressure until it became clear that the deal would indeed go through and after Bank of America had recouped all of the stock price losses that had occurred during the months of July to October following the deal announcement. The 400 shares we still held in November 2005 were sold for $26.04 and $26.59 on November 9 and November 21, respectively.

Our overall trading profit on these four roundtrips in MBNA was $1,115 of which $122 resulted from arbitrage trades based on purchases made after the deal had been announced.

Other arbitrage situations we played trading the stock of an acquisition target company in 2005 and 2006 were in the cases of Guidant (GDT—$172 profit from four round trips—see Chapter 4) and Univision (UNV—$207 profit from three round trip trades).

For contrarians who look for a price drop as an impetus to buy, the acquirer in an M&A transaction can also look interesting as a potential purchase because the price decline that typically affects it at the time the

acquisition is announced is often reversed later on. This is not just because the deal may turn out to be a fundamentally sound one and the price being paid is perfectly rational for the assets being acquired, but a recovery in the acquirer’s stock price can also subsequently occur even in those cases where the merits of the deal do turn out to be less than stellar. The fact is that a big corporation’s prospects are based on so much more than just the outcome of one transaction. Yet, when a big deal is in the news, it tends to drown out all other considerations affecting the acquirer’s prospects.

One case in point was the Bank of America/MBNA transaction, which we outlined earlier, where Bank of America’s stock was pressured down-ward by the pending acquisition for most of the six months prior to final closing of the deal. We took advantage of this decline in price, buying and selling Bank of America (BAC) twice during the period its MBNA acqui-sition was pending, with two trades netting $97. Here follow three more examples that aptly illustrate how a stock price decline relating to an ac-quisition that a company is making can prompt us to initiate trading in that stock. These three separate takeover situations involved Anadarko Petroleum Corporation, CVS Corp., and Norway’s Statoil ASA.

Anadarko Petroleum Corporation

Anadarko Petroleum Corporation (APC) is an oil and gas producer based in The Woodlands, Texas. On Friday, June 23, 2006, the company announced two major acquisitions in the oil and gas sector. APC agreed to acquire Kerr-McGee Corporation and Western Gas Resources for $21.1 billion in cash and the assumption of $2.2 billion in debt. Anadarko paid a steep pre-mium for both purchases and announced a program of asset sales to pay down debt, but concerns regarding the acquirer’s debt levels initially re-sulted in an immediate 7 percent drop in APC’s stock price on the day the deals were announced. Anadarko’s stock price closed at $44.90 on that day.

We bought 100 APC on Monday, June 26, 2006, at $43.91, and then traded 100-share lots as follows over subsequent months.

Bought 6/26/06 at $43.91 Sold 6/28/06 at $44.57 Profit= $55 Bought 7/17/06 at $43.70 Sold 7/18/06 at $44.45 Profit= $55 Bought 7/18/06 at $43.66 Sold 7/26/06 at $44.46 Profit= $60 Bought 9/12/06 at $43.86 Sold 9/13/06 at $44.70 Profit= $74 Bought 9/14/06 at $44.00 Sold 9/18/06 at $44.80 Profit= $70 Bought 9/19/06 at $43.87 Sold 9/28/06 at $44.47 Profit= $46 Bought 9/19/06 at $43.96 Sold 10/16/06 at $44.68 Profit= $52 Bought 9/20/06 at $42.68 Sold 9/27/06 at $43.35 Profit= $71 Bought 9/27/06 at $42.66 Sold 9/27/06 at $43.35 Profit= $59

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Bought 10/3/06 at $42.09 Sold 10/10/06 at $43.14 Profit= $95 Bought 12/18/06 at $43.91 Position still held at 2/28/07

Bought 12/22/06 at $42.43 Sold 12/27/06 at $43.13 Profit= $60 Bought 1/3/07 at $42.63 Sold 1/22/07 at $43.24 Profit= $51 Bought 1/22/07 at $42.63 Sold 1/23/07 at $43.23 Profit= $50 Bought 1/25/07 at $42.52 Sold 1/31/07 at $43.30 Profit= $68 Bought 2/6/07 at $42.14 Sold 2/7/07 at $42.83 Profit= $59 Bought 2/7/07 at $42.09 Position still held at 2/28/07

The 15 completed roundtrip trades in Anadarko netted us $925 in trad-ing profit.

CVS Corporation

Woonsocket, Rhode Island–based CVS Corporation (CVS), which operates one of the country’s largest chains of retail pharmacy stores, announced on November 1, 2006 an all-stock bid worth around $21.2 billion for Caremark Rx, a leading pharmacy benefit management company based in Nashville, Tennessee. CVS stock dropped 7.4 percent to close at $29.06 on the news.

We bought 100 CVS shares November 3 for $28.93 and then traded five additional 100-share lots as follows thereafter.

Bought 11/3/06 at $28.93 Sold 11/6/06 at $29.55 Profit= $52 Bought 11/9/06 at $28.99 Sold 11/16/06 at $29.58 Profit= $49 Bought 11/9/06 at $28.60 Sold 11/13/06 at $29.21 Profit= $51 Bought 11/17/06 at $28.91 Sold 12/5/06 at $29.57 Profit= $56 Bought 11/27/06 at $27.70 Sold 11/29/06 at $28.30 Profit= $50 Bought 11/27/06 at $27.32 Sold 11/29/06 at $27.92 Profit= $50

Then on December 18 came the announcement of a competing and higher bid by Express Scripts, also a pharmacy benefit management com-pany and a direct rival of Caremark Rx. We bought 100 shares of CVS early on in the day that the rival bid was announced in the belief that CVS share price would likely be pushed up on the news. We closed the roundtrip trade three days later.

Bought 12/18/06 at $29.94 Sold 12/21/06 at $30.65 Profit= $61

Our total profit from trading CVS seven times following its bid an-nouncement was $369.

Statoil ASA

Statoil (STO) is the largest oil and gas company in Scandinavia and is Norway’s largest company. Although the stock is publicly listed on both the Oslo and the New York stock exchanges, the Norwegian government maintains a controlling stake of 70.9 percent. The company produces oil and natural gas from Norway’s continental shelf in the North Sea, where it is the biggest producer, as well as from many other production opera-tions around the world. Statoil also operates around 2,000 gas staopera-tions in nine European countries. On December 18, 2006, Statoil announced that it would acquire the oil and gas operations of Norwegian conglomerate Norsk Hydro. The announcement initially caused a 4 percent drop in Sta-toil’s share price with the New York-quoted ADR closing at $26.74 on De-cember 18. But in the next weeks the stock price moved further south, reaching a low on January 10, 2007 of $23.66. We bought STO for the first time December 19, 2006 buying 200 shares at $26.33 and selling them that same day at $26.60. Our trades in the stock—200 shares each time—ran as follows:

Bought 12/19/06 at $26.33 Sold 12/19/06 at $26.60 Profit= $44 Bought 12/20/06 at $26.68 Sold 1/31/07 at $27.01 Profit= $56 Bought 1/10/07 at $24.02 Sold 1/12/07 at $24.36 Profit= $58 Bought 1/17/07 at $23.96 Sold 1/17/07 at $24.29 Profit= $56 Bought 2/8/07 at $25.74 Sold 2/8/07 at $26.00 Profit= $42 Bought 2/12/07 at $25.72 Sold 2/13/07 at $26.03 Profit= $52 Bought 2/20/07 at $25.47 Sold 2/21/07 at $25.78 Profit= $52 Bought 2/27/07 at $25.41 Position still held at 2/28/07

The last of these purchases was made during the strong market fall-back of February 27, 2007. Our profit on the seven roundtrip trades was $360.