Vertical Mergers & Binary Trade on ATVI

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.

Activision Blizzard – Another Pawleys buy-out!!!

Yesterday Microsoft announced it would buy Activision Blizzard for $95/share.  I bought shares of Activision in the Pawleys Dividend Fund, LP, and for clients in Separately Managed Accounts in late December for around $66.40/share.  This means in three short weeks, we have a gain of +43% to the cash buy-out price.  This is a phenomenal result!

Activision marks the 11th buy-out of stocks we have invested in for clients, which is incredible given that at any time I am managing only 30-35 individual stocks.  I am not trying to pick potential buy-outs, but it validates my selection criteria, which is identifying stocks that others deem to be very valuable, and are willing to pay big premiums to what we are paying.  I continue to believe that investing in stocks of companies with little or no debt, good earnings growth, and rock-solid cash-flow will best position portfolios to outperform the markets in a myriad of economic environments.

Proper portfolio construction and disciplined rebalancing is key to achieving good performance, but selecting quality stocks is just as critical.  The average gain on these buy-outs has been +40% – the list is attached below for those who are curious to see the history.  I am very thankful to have the trust and confidence of everyone, and am so happy to have delivered a nice result to start 2022.

Unicorn or Incumbent?

Which is better, a sparkly new unicorn company, or a tried and true incumbent? Microsoft went public in 1986, and the stock went for an adjusted $0.12/share – today it trades for $304. My calculator seized up when I tried to determine the percentage gain. We all wish we had sniffed out how successful this once-unicorn would become. On the flip side, I remember the day in early 2000 when, a glitzy but unprofitable company with a stratospheric valuation, went public. went out of business later that year, and became a symbol of how ridiculous the technology space had become, riddled with young, unprofitable, poorly run companies. The list of long-standing companies, however, that have gone bankrupt or even completely out of business is also long – Lehman Brothers and Kodak come quickly to mind. But some of the best performance returns still come from well-established companies. We hold several stocks with dizzying 5-year total returns: Lam Research +594%, Applied Materials +425%, Estee Lauder +354%, and United Health +212%. So what’s an investor to do – seek out the next colorful unicorn, or find a well-run growth company with a proven track record?

The transition to more clean energy is not a fleeting trend, but here to stay, and has good examples of both unicorns and incumbents. Last quarter Tesla, which finally posted a profit in 2020, generated $13.8 billion in revenue, while Ford generated $35.7 billion. Ford manufactured its first car in 1903, and Tesla produced its first car over a hundred years later in 2009. Notably, they are the only two American automakers that have avoided bankruptcy. Both are pioneers: Ford introduced the moving assembly line which increased production levels, while Tesla similarly pioneered electric vehicle production. Both companies inaugurated mass-market vehicle availability for the middle class. Henry Ford, who had previously worked for Thomas Edison, made an electric vehicle in 1901. But it took Tesla nipping at their heels over a hundred years later to push Ford into the mass-market electric vehicle space. Today, you can buy a pretty cool electrified Mustang Mach or F-150 truck.

The young, innovative energy of unicorns is perfectly married with the knowledge and experience of incumbents. The synergies created by these competitive connections are amazing as they each push for improvement. Both face the daunting challenge of achieving sustainable business models and profitability. And as Elon Musk says, “prototypes are easy, production is hard, and being cash-flow positive is excruciating.” There are many ways to succeed as an investor, but I believe that companies with little or no debt, good earnings growth, and rock-solid cash-flow, perform better over time. And all of these companies initially started out as unicorns, so it is best to remain open minded!

By the way, Merrill Lynch was the lead underwriter for, and their analysts maintained a buy rating throughout 2000 as the stock tumbled. It was a conflict of interest for sure, and another good reminder to consider the source of information about stocks, because often it is driven by marketing and is not good investment advice.

Sources: Refinitiv,