As readers of my column know, one of the primary options strategies I use in my stock advisory newsletter, The Liberty Portfolio, is selling naked puts. This strategy generates income and may result in buying stocks that I want in the portfolio. However, sometimes there are special situations that arise, in which a possible buyout or short squeeze makes the purchase of calls an attractive play.
These situations are very, very rare. There is a danger in making speculations on buyouts, because even companies that seem like prime candidates for acquisition may never receive actual interest.
That’s why you have to be an expert in a given stock or company to really know the possibilities regarding acquisitions or short squeezes. With calls on these specific stocks, you are making an educated gamble. It isn’t an investment, but it is a trade, and one that you’ve taken a good look at.
And right now, here are three candidates that I see.
Calls to Buy on Potential Buyouts: Pandora (P)
Pandora Media Inc (NYSE:P) seems like an obvious buyout candidate. That’s because Sirius XM Holdings Inc. (NASDAQ:SIRI) made a $480 million investment in Pandora stock. The key is that SIRI is owned by Liberty Media, aka John Malone. Sirius XM offered $15 a share to buy out Pandora in 2016, got turned down, turned down an $8 bid, and ended up with the $480 million investment.
John Malone traditionally makes investments in companies that he intends to acquire most, or all, of. He also installed Sling TV’s founder, Roger Lynch, as the new CEO. Sling TV used to be owned by … Liberty Media.
Malone is going to have Lynch come in and turn the company around. I expect an acquisition in 18 months around $12 per share. P stock trades at $8.67. I would consider buying the 18 Jan 2019 $5 calls for $4.25-$4.50, then sit and wait for a 30%-35% return.
Calls to Buy on Potential Buyouts: Rite Aid (RAD)
Rite Aid Corporation (NYSE:RAD) is probably going to get sold. Cerberus Capital already wanted to buy some of its stores. Private equity is the more likely candidate because PE shops come in, slash expenses, reposition assets and then spin companies back out to exit with a big return. RAD is a perfect candidate. Management clearly has no interest in improving operations. They get more value out of selling the company than trying to turn the company around.
RAD will soon have far less debt to deal with, and that will increase its cash flow. Private equity loves cash flow, because it allows for flexibility. During the speculation about the Walgreens Boots Alliance Inc (NASDAQ:WBA) merger, RAD stock was trading between $6 and $7. Now it’s at $2.28.
Consider buying the 18 Jan 2019 $2 calls for 90 cents to $1. You may see a double or even triple bagger.
Calls to Buy on Potential Buyouts: Lululemon (LULU)
I’m not quite as convinced about Lululemon Athletica Inc. (NASDAQ:LULU) being acquired, but these rumors have been floating around for some time. The obvious choice is Under Armour Inc (NYSE:UAA), although other clothing companies and even a private buyout is conceivable. We are at a point where these high-flying clothing retailers are starting to slow down in growth, which is when M&A becomes more likely. They merge to give themselves better chances at surviving and so they can stop competing with each other.
LULU has a much better cash flow situation, with solid and consistent free cash flow. UAA has had negative free cash flow. LULU may not want to merge with that partner, but perhaps instead go private or go with Nike Inc (NYSE:NKE).
Regardless, I think LULU would go out around $70, to be conservative. LULU is at $59.75. I would buy the 16 Mar $60 calls for around $6.75, although I don’t think the upside here makes it worth the risk.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He owns share of P and RAD. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.