Southwest Airlines Co.’s (NYSE: LUV) $1.4 billion acquisition of AirTran Holdings, Inc. (NYSE: AAI) is an interesting mix following the merger of Continental Airlines, Inc. (NYSE: CAL) and UAL Corporation (NASDAQ: UAUA).
AirTran shareholders will receive $3.75 in cash and 0.321 Southwest shares for each share of AirTran, valuing it at $7.69 a share — a 69% premium to Friday’s closing price based upon the Southwest share price. There is also a collar around the per-share price of $7.25 to $7.75, so as LUV moves, so will AAI.
Before the deal was announced, AAI’s 52-week high was just over $6 per share. If you include AirTran’s net debt and capitalized aircraft operating leases, the total price of the transaction is valued at roughly $3.4 billion.
While AirTran shares were at $4.55 on Friday, there is a possibility that a higher bid could come. Shares did challenge the $6 level in two earlier waves in 2010. Many shareholders will be happy with the current offer, but some will want more. If you go back to October 2007, before the recession was in full swing, AirTran was a $10 stock. In 2006, it was an $18 stock.
So let’s look at some low-premium, all-or-nothing option trades that could garner a high return if another bid materializes.
The lowest-premium bets are the AAI Oct 7.50 Calls at 10 cents, followed by the AAI Nov 8 Calls at 5 cents. Deciding which call to go with is a toss up. If a higher bid is made, it may not happen before October expiration, which occurs on Oct. 15. So while the $8 strike may seem ambitious, the November expiration gives you close to seven weeks’ worth of time value.
Keep in mind that Southwest’s share price alone could dictate a higher price for AAI based upon the stock component. That assumes a rise in Southwest shares, and we’ll spare you the Tom Clancy analogy about assumptions.
Maybe there will be a higher bid, maybe not. The deal is being investigated already and the $9.8 billion market cap of Southwest leaves plenty of room for the company to raise its bid if it needs or wants to.
Like I said, this is an all-or-nothing option trade — we will likely see exponential returns or they will expire worthless.
Follow Jon Ogg on Twitter @jonogg.
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