The opportunity to make a nice profit from a merger arbitrage trade in Dell (DELL) -- betting that the ultimate buyout price will be higher than the current stock price (as well as giving consideration to duration until the deal's close) -- is all but coming to an end.
At the beginning of 2013, when Dell shares were changing hands for around $10.70, I named the company as my favorite pick for 2013. It was a simple pick based on the then-current price relative to value received. Although I suggested that owning the common stock was a very worthy move, I also outlined my reasons for opting to own the January 2015 $7 calls, which were trading for about $4 to $4.10.
Lady Luck graced me with her presence when Dell announced a deal to be taken private by a consortium for $13.65 a share. A week or so after the deal was announced, I sold the option position for about $6.55. Sure, it was premature, but I was not complaining (and neither were a few Real Money readers I heard from) about a 55% to 60% gain in less than four weeks.
Shortly thereafter, Southeastern Asset Management, Dell's largest outside shareholder, displayed the value of conviction and independent rational thinking by announcing that it was opposed to the proposed buyout because it grossly undervalued Dell's share. SEA had publicly stated that it believes Dell to be worth north of $20 a share. Shortly thereafter, Carl Icahn announced that he had bought a big stake in Dell and that he too opposed the buyout, suggesting Dell was worth significantly more.
Since those two shareholders, along with T. Rowe Price, were stating they would oppose the buyout -- and since CEO Michael Dell was not voting his shares -- I decided that there was more room left. On a Columnist Conversation post, I indicated that I had reopened my Dell trade. This time I bought the January 2014 $10 call options, paying around $4.20. I went with the 2014 rather than the 2015, believing that a deal or a definitive agreement would be concluded by year's end, so why pay for the additional time premium?
Dell now trades for $14.50 a share, as both Icahn and Blackstone have indicated interest in buying the company. Blackstone's offer of $14.65 is the one on the table right now, but the ultimate takeout number could be $15 or slightly north of $15. What's different, however, is that the new buyer is not tendering for the entire company, so firms such as Southeastern, which believes Dell is worth more than $15, will hold on, while those that want to cash out now can do so. Those deal terms imply that majority approval will be given, so if you're betting on a price above $15, I'm not so sure.
If $15 is the ultimate buyout price, there is still a little upside left, so for now I'm holding on to my position. But I'm sitting on a 10% to 15% gain, so even if I exit in a month without any further upside, my annualized return is very satisfactory. I certainly wouldn't bet against Southeastern, and if Dell can pull an IBM (IBM)-like turnaround over the next couple of years, shares could be worth far north of $20. But I liked the margin of safety a lot better when Dell was trading below $13.
Astute investors should keep the following in mind: Michael Dell's and Sliver Lake's decision to take out the company at $13.65 was not an act of charity. They were out to make money, and one theory suggests that the buyout was an attempt to get the company on the cheap by offering a premium when shares fell below $10. Also, Blackstone and Icahn are capitalists, and they clearly believe that at $15, Dell shares are widely attractive. If you are a patient investor, perhaps Dell should be near the top of your list.