Playing the Time Warner / AT&T Deal with Options

By Lawrence G. McMillan

Time Warner (TWX) agreed to be bought by AT&T (T).  The deal is worth $107.50 – consisting of $53.75 in cash and $53.75 in AT&T stock.  The stock portion has collars: TWX shareholders will receive a maximum of 1.437 shares of AT&T, but will not receive less than 1.30 shares of AT&T.  Those two limits on the shares are equivalent to AT&T stock prices of $37.411 and $41.349, respectively (Just divide the share limits into the $53.75 stock value to get those prices).  

Hence, the deal will be worth $107.50 if AT&T stock is between $37.411 and $41.349 at the deal’s closing.  AT&T stock has already fallen below the lower collar, trading at 36.70, so the deal is worth less than $107.50 using current prices.  The TWX stock is way below the takeover price, though, because of antitrust concerns and the fact that the deal will probably take at least a year to close.  

From what I’ve read, the antitrust concerns should not be great, but they are.  Perhaps it will become a political football.   So one might think that there is an opportunity here.  However, because of the massive amount of time that it would take to complete a deal, buying options is going to be difficult.  Let’s look at an example.

A January (2018) 85 call is selling for 9.60, for example.  Hence the TWX stock would have to be above 94.60 (85 + 9.60) at expiration (or at the time of the closing, if the deal closes before January 2018 option expiration) for the call purchase to be profitable.  

Looking at a positive result, one could sell the call for $22.50 if the takeover were closed at the $107.50 price.   In fact, the deal would be worth even more than that if AT&T stock were to be above the higher collar ($41.349) when the deal closes.  That is certainly possible, since AT&T stock was at that price just last month.

On the other hand, if the deal closes that doesn’t necessarily mean this call purchase would be profitable.  For if AT&T stock drops in price, there would still be risk. AT&T’s stock price would have to be below $28.42 (see Footnote below) in order to make the deal value less than $94.60 – the breakeven price for the call purchase.  AT&T stock hasn’t been that low since late 2011, but it’s not out of the question.  So, while this is modestly attractive, we are not going to buy long-term calls now.  We’ll keep an eye on this though.

Footnote 1: If AT&T falls below 37.411, the TWX shareholder would receive 1.437 shares of AT&T stock.  So, to see what AT&T stock price would produce a deal price of $94.60 – the breakeven in this situation – one must solve the following equation for x:       
                    94.60 = 53.75 + 1.437x
                             So, x = 28.42

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