Bill Gross, the eponymous Bond King, is wading into the stock market to advise investors. Worryingly, he pointed to an imminent fourth-quarter recession closing out 2023. In the same X post, though, Gross hinted investors can capture hidden upside in equity arbitrage.
Known in shorthand as “equity arb,” the strategy requires research, speed, and a little luck. In short, equity arb involves identifying a stock ripe for acquisition and buying shares before a merger. The difference between your purchase price and the acquiring firm’s sale price is your profit opportunity. Furthermore, while getting in before an announcement is ideal, it isn’t practical since there are so many unknowns.
But even after a firm announces an acquisition target and purchase price, investors can still capitalize on equity arb opportunity.
On October 11th, ExxonMobil (NYSE:XOM) announced a merger with Pioneer Natural Resources (NYSE:PDX). The purchase price for PDX is set at $253 per share. Unsurprisingly, PDX shares popped to $250 – but didn’t quite reach the per-share purchase price. Today, pre-merger, shares trade at about $245, indicating 3% profit potential through equity arb.
However, the risk inherent in equity arb is that a merger may not come to fruition, even if announced. When this happens, shares of the acquired company typically plummet and destroy investor gains. Even if a merger happens on schedule, the waiting period can be lengthy. When fixed-income assets generate a 5%+ yield, you’ll need to find equity arb opportunities that beat Treasuries over an equivalent waiting period.
Bill Gross loves these three stocks for equity arb – but are they solid or speculation?
Capri Holdings Ltd (CPRI)
Capri Holdings Ltd (NYSE:CPRI) is set to close a merger with Tapestry Inc (NYSE:TPR) by 2024. Tapestry is a luxury fashion brand that owns the famous Coach handbag line. Capri Holdings, is also a luxury fashion firm that owns Versace and Michael Kors.
The $8.5 billion deal sets a per-share price of $57 for existing CPRI investors. Prices spiked nearly 50% right after the announcement before settling in the low-$50 range. Today, this Bill Gross stock pick offers a 14% upside for equity arb investing. That’s a hefty return for little work, but there’s risk in this deal that investors should balance.
Capri’s product lines, prime for a robust economy and high consumer spending, are struggling. Sales are worse than stagnant, falling nearly 10% in recent reports, and earnings dropping by more than 75%. The company reports earnings next week but investors won’t likely see a huge jump in CPRI’s bottom-line stats. In my opinion, this Bill Gross stock is more trouble than it’s worth, considering its precarious position and the likelihood that the deal could collapse in light of poor performance.
Seagen Inc (SGEN)
The deal sets SGEN’s per-share price at $229. Shares are steadily climbing in anticipation of a late-2023 close. But there’s still about a 6.5% upside for equity arb traders. The return is somewhat low, considering high-yield bonds offer 7% or more. This Bill Gross stock is a solid play with little risk of collapse.
Yet, some concern is warranted. In July, the Federal Trade Commission asked for further details about the specifics of the $43 billion merger. Truthfully, the FTC asks for more information in about 25% of merger deals, further challenging companies only 5% of the time thereafter.
But let’s consider PFE’s industry dominance and the unique cancer therapeutic portfolio SGEN brings. Ultimately, this Bill Gross stock pick combines equity arb upside and long-term potential if investors hold post-merger.
VMware, Inc (VMW)
Unfortunately, equity arb investors might have missed the boat on VMware, Inc. (NYSE:VMW). The cloud computing firm, set to merge with semiconductor stock Broadcom (NASDAQ:AVGO), already trades beyond its merger pricing. Shares trade around $145, and the deal values each at just $142.50. Furthermore, ongoing concerns about the deal represent a real risk for investors.
The deal hinges on Chinese regulatory approval, and delays in the process are stalling completion. The deal was supposed to close on October 30th. That came and went without finalization. The merger agreement expires on November 26th, and the clock is rapidly ticking on this Bill Gross stock. Beyond pure bureaucratic slowness, some assess the deal’s delay as fallout from struggling U.S./Chinese political relations.
Too much uncertainty surrounds this Bill Gross stock to make it a viable play. Combine that risk with zero equity arb upside, and investors should avoid this opportunity.
On the date of publication, Jeremy Flint held no positions in the securities mentioned. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.