Monday, February 1, 2010

Talbots (TLB) and (BPW) Takeover - Arb or Not?

TLB is trading 11.40, BPW is 10.27 . The LIVEVOL™ Pro Summaries are below.

TLB has traded nerly 14,000 option contracts in the first 3 hours on total daily average volume of 4,654. The Company Tab snapshot is included below (click to enlarge).

This is the news from Reuters Key Developments (soon to be available on Livevol Pro).

PW Acquisition Corp. And The Talbots, Inc. Sign Definitive Merger Agreement
BPW Acquisition Corp. announced that it has entered into a definitive merger agreement pursuant to which it will be acquired by The Talbots, Inc. Upon closing the combined company will retain Talbots' ticker symbol [snip]. Under the terms of the merger agreement, the proceeds of BPW`s cash-in-trust of approximately $350 million, in conjunction with [snip] a new $200 million revolving credit facility [snip] will be used to retire all of Talbots` existing debt. In addition, Talbots will acquire all of the outstanding shares of Talbots common stock held by AEON (U.S.A.), Inc., which represents a more than 54% stake currently. BPW common shares will be exchanged for the equivalent of $11.25 per BPW share in Talbots` common shares within a floating exchange ratio range of between 0.9000 - 1.3235 Talbots shares per BPW share, [snip] BPW`s shareholders will own between approximately 60-69% of Talbots` common shares.

With an 11.25 resulting share value for BPW shareholders a trading opportunity seems to exist. Buy 10.27 stock and sell it later at 11.25 to make 0.98. The risk is that TLB price goes down a lot, so even 1.3235 * price < 10.27. But that would require TLB to go down to 7.76. There is some non-zero probability that occurs. How about this...

TLB is trading at 11.40. So you could buy the 10.27 stock and sell it instantaneously at 11.40 (no stock price risk). This "arb" is causing substantial short interest in TLB making it "hard-to-borrow." The TLB Options Tab is included below (click to enlarge).

The reversal/conversion for TLB indicates that there is a substantial negative implied rate to borrow TLB.

R/C Calcs
Feb 12.5
Buy Calls 0.15
Sell Puts 1.50

Synthetic Long Stock: 12.5 + 0.15 - 1.50 = 11.15
Sell real stock: 11.40
Receive: $11.40 - $11.15 = $0.25

$0.25 implies 46% (annual) interest rate in Feb. on an 11.40 stock price. Or, in other words, it costs 46% fair value to borrow TLB. Then, looking at the trade-off of buying BPW and selling TLB (and paying 46% to short TLB) looks "less good."

For completeness, the implied rate (mid-market) to reverse in March is:
R/C Calcs
Mar 12.5
Buy Calls 0.35
Sell Puts 2.25

Synthetic Long Stock: 12.5 + 0.35 - 2.25 =
Sell real stock: 10.60
Receive: $11.40 - $10.60 = $0.80

$0.80 implies 58% to March expo. i.e. Pay 58% (annual) to borrow TLB to March expo. If the trade was good by 11.40 - 10.27 = 1.13 and you have to pay 0.80 to be short, the trade is less good. Take into account that the short rate can get much higher and the risk that shorts may be forced to buy the stock back on a huge rally (short squeeze), this goes from a clear arb, to a not so clear trade.

Adding a little more uncertainty to the outcome is this news: "Talbots shareholder sues retailer over Aeon deal." You can read that article from Reuters: HERE

My conclusion - definitely not a "risk free" arb...

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