A Merger Trading Strategy
The news was straightforward. Business Wire recently reported,
Entegris, Inc. (ENTG), a leader in specialty chemicals and advanced materials solutions for the microelectronics industry, and Versum Materials, Inc. (NYSE: VSM), a leading specialty materials supplier to the semiconductor industry, announced that they have agreed to combine in a merger of equals.
Shares of VSM jumped on the news.
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The combined company will be a premier specialty materials company for the semiconductor and other high-tech industries.
Under the terms of the agreement, which was unanimously approved by the Boards of Directors of both companies, Versum Materials stockholders will receive 1.120 shares of Entegris for each existing Versum Materials share.
Upon completion of the merger, Entegris stockholders will own 52.5 percent and Versum Materials stockholders will own 47.5 percent of the combined company.
The combined company will have a pro forma enterprise value of approximately $9 billion, based on the closing prices of Entegris and Versum Materials on January 25, 2019, and approximately $3 billion in revenue and approximately $1 billion in Adjusted EBITDA on a pro forma basis for calendar year 2018.
The companies cited several compelling strategic and financial benefits of the merger, including:
- Enhanced product breadth and depth: Entegris and Versum Materials have highly complementary portfolios that combined will bring customers enhanced technical capabilities.
This merger will create the world’s first comprehensive and effective end-to-end materials solutions provider across the entire semiconductor manufacturing process.
The combined company is expected to have a full suite of diversified product offerings including Advanced Materials, Specialty Gases, Microcontamination Control, Advanced Materials Handling, and Delivery Systems and Services.
- World class technology: The combined company’s world class technology and R&D capabilities will better enable it to address customers’ evolving needs for new materials as device architectures become more complex; capitalize on the increasing demand for purity and help drive improved yield; and accelerate the development and time to market of new technologies that align with the industry technology roadmap.
- Global scale and operational excellence: A much broader, global scale will enable the combined company to reach additional customer touch points and have increased relevance in key geographies. By combining its extensive global manufacturing network, the company will be able to improve delivery times and drive new levels of operational efficiencies and excellence.
- Increased financial strength and flexibility: The combined company will have approximately $3 billion in revenue and approximately $1 billion in Adjusted EBITDA on a pro forma basis for calendar year 2018.
It will be well capitalized with a strong balance sheet and a pro forma net leverage ratio of 1.1×4. In addition, it will have flexibility to invest, make acquisitions, and return capital to stockholders, while enjoying greater earnings stability and margin growth potential.
The transaction is expected to close in the second half of 2019, subject to the satisfaction of customary closing conditions, including receipt of U.S. and international regulatory approvals, and approval by the stockholders of each company.
The deal may benefit share holders in the long run but there is some risk it will not close. The deal will not push VSM to its previous highs and that could lead to an alternative deal.
A Trade for Short Term Bulls
As with the ownership of any stock, buying VSM could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for VSM
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For VSM, the March 15 options allow a trader to gain exposure to the stock.
A March 15 $37.50 call option can be bought for about $1.65 and the March 15 $40 call could be sold for about $1.10. This trade would cost $0.55 to open, or $55 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $55.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in VSM the maximum gain is $1.95 ($40 – $37.50 = $2.50; $2.50 – $0.55 = $1.95). This represents $195 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $55 to open this trade.
That is a potential gain of about 254% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.