In the past I have written about Cigna twice: once regarding the proposed merger with Aetna, and once about their buy-out of Express Scripts. In both instances the respective stocks, CI and ESRX, traded at discounts to the proposed deal prices, presenting a potential opportunity for investors. We took advantage, and even though one deal fell apart and the other went through, made profitable trades on both. To be clear, I would never advocate buying a stock with a pending buy-out or merger unless we thought it was a good company to own, because deals often fall apart.
Last week Microsoft announced a planned buy-out of Activision Blizzard for $95/share in cash. ATVI is a holding in the Pawleys Dividend Fund and if the deal closes, represents a +43% gain to our initial entry point less than a month ago. ATVI rose quickly after the announcement, only to settle and drift lower. Today it hovers around $79/share, which is a 20% discount to the proposed buy-out price. Simply put, the market does not believe the deal will close, and the fancy word for trying to take advantage of the 20% price difference is referred to as “arbitrage.” True, over the past several years there has been more government scrutiny over vertical mergers, where two companies within the same industry but at different places along the supply chain join together. And it is well know that there is bi-partisan support to limit the powers of large technology companies here in the U.S. – which is truly amazing given how wide the political moat has become. The media has been hot in covering gaming, virtual reality, and the Metaverse, but the benefit of Microsoft acquiring Activision goes well beyond that, and will take the new norm of work-from home into the virtual reality space, re-creating the connection of being together at the office and beyond.
The newsfeed is going to get very noisy as we approach mid-term elections, so keep your seatbelts tightened! Anti-trust and the excessive power of large technology companies will be a hot topic for candidates. I believe the buy-out of ATVI will happen, but if it fails any buyer of the stock will end up holding a good company with very little debt, good earnings growth, and rock-solid cash-flow. The $3 billion break-up fee that Microsoft would have to pay Activision applies even under an anti-trust failure. The market capitalization of ATVI is $64 billion, and they carry long-term debt of just $3.61 billion. The break-up fee alone is enough to cover almost all of their long-term debt, and is well above earnings for an entire quarter, which has averaged $2.28 billion over the past year. I remain confident that stocks of companies with little or no debt, good earnings growth, and rock-solid cash-flow will perform well in a myriad of economic environments. We will find out by early 2023 if the MSFT/ATVI buy-out closes. In the meantime, the landscape is ripe for additional mergers and acquisitions going forward, so we may see additional activity in the Pawleys Funds as others find value in the stocks we have selected.