OATS -- worth a gamble? (arbitrage bet)

[Shoe]

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The only way I can see shorting WFMI working is if you were sure they would drop more than OATS if the deal is blocked, and go up less than OATS if the deal is approved, which does seem reasonable to me, which means you could lock in a profit either way. The part i'm not sure on is the which stock would get hit worse if the deal is blocked.

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Seriously, can you just wait a little longer before you post and read these things out loud?

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That makes perfect sense to me.... someone please explain to me why else you would short? If the deal gets approved, both stocks are going up. If it gets blocked, both stocks are going down. If they went up or down at the same rate, shorting would ensure that you neither make nor lose money on the trade, which would make it pointless. How does that not make sense?

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You don't see anything weird about the sections I bolded? You basically said, "Hey man, makes sense that WF would drop more if the deal gets blocked, good call! Damn, sure would be sweet if I could figure out which one would drop more if the deal got blocked."

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I'm saying that logically, to me, it would make sense. But i'm not sure if the market thinks the same way I do on this. That's why I say, it makes sense to me, but i'm not sure (how the market would actually react). There is nothing that guarantees WF would drop more than OATS, that is just pure speculation to me.

[Evan]

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It's not just pure speculation though. There is an offer price on the table (in this case $18.50 per share). You are analyzing the risk of the deal going through vs. not going through. You buy if the chances of the deal going through outweigh the risks of how much the stock would drop if the deal does not go through.

Before I started this thread I thought merger arbitrage was the only form of arbitrage. I did not realize there was another form where you are buying/selling at the same time for an instant, risk-free gain.

The method I am talking about in this thread has been used by Warren Buffet many times in the past, and is part of the reason he was so successful early in his career.

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Okay, Buffet, let's hear your analysis. Analyze the risk and the benefit and all that good stuff, because so far you haven't done any of that. Without doing any of that it is, indeed, pure speculation.

I hate when people feel the need to cite things Buffet has done as though it's some esoteric secret that they've discovered through earth shattering first hand research.

[Shoe]

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It's not just pure speculation though. There is an offer price on the table (in this case $18.50 per share). You are analyzing the risk of the deal going through vs. not going through. You buy if the chances of the deal going through outweigh the risks of how much the stock would drop if the deal does not go through.

Before I started this thread I thought merger arbitrage was the only form of arbitrage. I did not realize there was another form where you are buying/selling at the same time for an instant, risk-free gain.

The method I am talking about in this thread has been used by Warren Buffet many times in the past, and is part of the reason he was so successful early in his career.

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Okay, Buffet, let's hear your analysis. Analyze the risk and the benefit and all that good stuff, because so far you haven't done any of that. Without doing any of that it is, indeed, pure speculation.

I hate when people feel the need to cite things Buffet has done as though it's some esoteric secret that they've discovered through earth shattering first hand research.

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I wasn't citing Buffet as to say this is a good idea or not. I was citing Buffet to provide support for using the term arbitrage. I agree if I did this today it would be speculation, as I have not done any research on the deal. I wanted to hear what all the other speculators in this forum thought, not start a big arguement on what is or is not arbitrage. For that, I apologize.

[Evan]

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It's not just pure speculation though. There is an offer price on the table (in this case $18.50 per share). You are analyzing the risk of the deal going through vs. not going through. You buy if the chances of the deal going through outweigh the risks of how much the stock would drop if the deal does not go through.

Before I started this thread I thought merger arbitrage was the only form of arbitrage. I did not realize there was another form where you are buying/selling at the same time for an instant, risk-free gain.

The method I am talking about in this thread has been used by Warren Buffet many times in the past, and is part of the reason he was so successful early in his career.

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Okay, Buffet, let's hear your analysis. Analyze the risk and the benefit and all that good stuff, because so far you haven't done any of that. Without doing any of that it is, indeed, pure speculation.

I hate when people feel the need to cite things Buffet has done as though it's some esoteric secret that they've discovered through earth shattering first hand research.

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I wasn't citing Buffet as to say this is a good idea or not. I was citing Buffet to provide support for using the term arbitrage.

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Okay then, that's even worse. I'll make this the last time I point out that you haven't done ANY analysis of the probabilities of success, associated risk or pretty much anything. I'm gonna go ahead and guess that's not the way Buffet did it.

[Shoe]

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It's not just pure speculation though. There is an offer price on the table (in this case $18.50 per share). You are analyzing the risk of the deal going through vs. not going through. You buy if the chances of the deal going through outweigh the risks of how much the stock would drop if the deal does not go through.

Before I started this thread I thought merger arbitrage was the only form of arbitrage. I did not realize there was another form where you are buying/selling at the same time for an instant, risk-free gain.

The method I am talking about in this thread has been used by Warren Buffet many times in the past, and is part of the reason he was so successful early in his career.

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Okay, Buffet, let's hear your analysis. Analyze the risk and the benefit and all that good stuff, because so far you haven't done any of that. Without doing any of that it is, indeed, pure speculation.

I hate when people feel the need to cite things Buffet has done as though it's some esoteric secret that they've discovered through earth shattering first hand research.

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I wasn't citing Buffet as to say this is a good idea or not. I was citing Buffet to provide support for using the term arbitrage.

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Okay then, that's even worse. I'll make this the last time I point out that you haven't done ANY analysis of the probabilities of success, associated risk or pretty much anything. I'm gonna go ahead and guess that's not the way Buffet did it.

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I'm also going to guess that is why I titled this thread "worth a gamble?" instead of "Great arbitrage bet!!!"

I came here looking for opinions on the deal going through, not to recommend or suggest that this is a good deal to anyone (which you seem to be implying).

[Leaky Eye]

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I have looked it up and I still don't get it. If the merger gets approved, OATS is going to jump up to the $18.50 range, somewhere around a 25% gain. If the merger gets approved, Whole foods (WFMI) is probably going to go up too, so if the deal gets approved that short would cost me money not make me money.

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The purpose of the corresponding short in a stock buyout is to fix the price of your play. In this case you would have already sold the whole foods stock you plan to acquire in the takeover, so you know it can't move either way.

If you believe that whole foods will go up despite being diluted with a purchase at a premium, then you would not want to fix the price. In that sense you are correct I guess.

[Shoe]

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I have looked it up and I still don't get it. If the merger gets approved, OATS is going to jump up to the $18.50 range, somewhere around a 25% gain. If the merger gets approved, Whole foods (WFMI) is probably going to go up too, so if the deal gets approved that short would cost me money not make me money.

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The purpose of the corresponding short in a stock buyout is to fix the price of your play. In this case you would have already sold the whole foods stock you plan to acquire in the takeover, so you know it can't move either way.

If you believe that whole foods will go up despite being diluted with a purchase at a premium, then you would not want to fix the price. In that sense you are correct I guess.

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Thanks. I do believe that Whole foods will go up if the merger is approved (atleast short-term -- prop bet anyone?) . Therefore, if after careful analysis, it is determined that buying OATS is +EV, it would not make any sense to short Whole foods.

[DesertCat]

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i think evan, and most, understand the merger arb strategy.


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Of course. I thought I was being leveled here or something, when I guess I leveled myself

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About the Transaction: On February 21, 2007, Whole Foods Market entered into a merger agreement with Wild Oats, pursuant to which Whole Foods Market, through a wholly-owned subsidiary, has commenced a tender offer to purchase all of the outstanding shares of Wild Oats at a purchase price of $18.50 per share in cash. On June 7, 2007, the Federal Trade Commission (FTC) filed a suit in the federal district court to block the proposed acquisition on antitrust grounds and seeking a temporary restraining order and preliminary injunction pending a trial on the merits. Whole Foods Market and Wild Oats consented to a temporary restraining order pending a hearing on the preliminary injunction, which has been scheduled to commence on July 31, 2007 and to conclude on August 1, 2007.

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Shoe,

In a cash only deal (which by the description this is) you don't have to care about shorting the acquirer's stock. Evan is just trying to point out to you that you don't understand the key mechanics of merger arb, including when you have to short and when you don't.

Most mergers are stock deals, and it's a common tool to use short positions in them. For example if this was a stock deal, WFMI would have offered about .4 shares of WFMI (then worth $46) for each share of OATS to pay the $18.50. But right now .4 shares of WFMI are worth $14.60. So a merger arb would short WFMI to protect from a decline in the value of the WFMI shares. This locks in the value of the spread, i.e. they make the same profit whether WFMI goes up or down, as what they lose on the short they gain on the shares you will receive, and vica versa.

The big risk with shorting to lock in your spread is that if the deal falls apart, the aquirer may shoot up if the market hated the deal. So you could lose on both your long and short positions. It's an excess deal failure risk you need to be aware of and get compensated for.

And I was being too simplistic when I told you to use the previous trading range for OATS to give estimate the loss if the deal fails. OATS may trade above or below that range and it's part of the process to try to estimate where it will trade. Sometimes deals fail because the acquirer realizes there are big problems with the company they are buying, and when they cancel the deal the rest of the street finds out as well and the company's stock plunges.

When I do merger arb I stick to cash only deals so I don't have to deal with the risks of a short position in a failed deal. I also prefer to get involved in "take unders" where the buyer is getting such screaming deal that I'd be happy to continue owning shares in the acquiree. That way if the deal fails I don't care where the acquiree trades, i'm going to hold the stock. And if the deal goes through I take my small short term profit.

But to do this you have to be able to value a business. Otherwise you can only handicap deal success likelyhood and hoping the acquiree stock won't get killed if the deal fails. In the case of OATS, clearly the market believes there is little chance the deal will succeed. So you are likely to be stuck with OATS stock, and it's likely you will only be able to sell it at some lower price. And even if you are right, you are only getting a 20%ish gain out of it. I prefer to look for deals with smaller spreads but that are no-brainers to get done.

[Shoe]

Thank you. Great post. That is exactly the type of information I was looking for.

I think part of the confusion about shorting that set in earlier in this thread is that I knew it was a cash deal but did not realize the difference between a cash deal and a stock deal (such as the Sirius/XM deal -- in that case I would definitely support shorting).

Thanks for taking the time to respond to this thread. I always find your posts most helpful and extremely accurate.

[DcifrThs]

i was under the impression that even in cash acquisitions, the market has historically shown that the price paid for the acquired is at the time typically viewed as too high (another example of a winner's curse) and thus in most cases the acquirer's stock falls as a result of the purchase.

further, a "merger arb" bet is just that since you go long one stock and short another where both have (in most cases) similar characteristics & thus you have removed a market risk from your bet. if the market tanks, both stocks will likely fall (and you're covered in that on the short, presuming you've done it right in risk space). if the market jumps, both stocks will likely rise.

the "arb" comes in in that you are betting on the spread between the purchaser and the purchasee to narrow where the purchaser's stock falls the the purchasee's stock rises.

that was at least my impression though so if i'm wrong lemme know (and it may indeed turn out that i know less about merger arb than i initially thought... and i initially thought i didn't know much )

Barron