In May of 2016, a client asked us to review the choices within her 401(k), which included company stock.  There was, at the time, a pending buy-out of the company, so when we reviewed the stock, we anticipated that it would be trading at parity with the buy-out price.  The board of directors and shareholders of both companies had already approved the transaction.

Much to our surprise, the company stock of our client was trading at a 35% discount to the buy-out level.  Clearly, the market did not believe the transaction would complete.  The merger was being reviewed by the Department of Justice for anti-trust issues.  Several high-profile mergers had fallen apart amidst government anti-trust concerns, including Office Depot & Staples, Sysco & U.S. Foods, and Halliburton & Baker Hughes.  We classify a pending buy-out which may be blocked as a binary event.  There are only 2 possible outcomes: either the companies will merge, or they will not.  We liked the fundamental financials and the valuation of the stock, and recommend a long position to the client regardless of the outcome of the pending merger.

How does the story end?  The merger fell apart.  Both the Department of Justice and a U.S District Court judge ruled that the merger would have violated Section 7 of the Clayton Antitrust Act.  This spring, the acquiring company announced it was backing away from the acquisition.  But the trade worked out due to the solid fundamentals of the company.  We entered the stock at $130/share, and it recently traded at $193, representing a 48% premium over 17 months.

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