This Acquisition Sets Up A Potential 99% Gain
The news appeared to be fairly typical. GlobeNewswire reported, Parker Hannifin Corporation (NYSE: PH), the global leader in motion and control technologies, today completed its acquisition of Exotic Metals Forming Company LLC for $1.725 billion in cash.
Exotic is a manufacturer of innovative and technically demanding, high-temperature, high-pressure air and exhaust management solutions for aircraft and engines.
The transaction is expected to be accretive to Parker’s organic growth, EBITDA margin, EPS and cash flow, after adjusting for one-time costs, and to achieve high single-digit ROIC in year five with continued expansion. “
Accretive indicates the deal should immediately boost earnings. This could explain why the stock jumped on the news.
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GlobeNewswire continued, “Exotic’s high-temperature engine build-up technologies, engine exhaust nozzles, complex engine turbine hot section assemblies, and airframe and engine ducting will complement Parker’s portfolio of flight control, fuel and inerting, hydraulics, fluid conveyance and engine technologies.
“We are pleased to welcome the Exotic team to Parker,” said Tom Williams, Chairman and Chief Executive Officer of Parker.
“The addition of Exotic significantly expands our capabilities and increases Parker’s offering in the attractive engine segment, serving high growth programs. This strategic transaction reinforces our stated objective to invest in attractive margin, growth businesses, such as aerospace, that accelerate us towards top-quartile financial performance.”
“The addition of Exotic to the Parker Aerospace Group creates significant growth opportunities,” said Roger Sherrard, Vice President and President – Aerospace Group.
“Exotic will operate as a stand-alone division within the group, specializing in some of the most complex and demanding aircraft applications. Their unique products and proprietary manufacturing capabilities will complement Parker Aerospace products and solutions, resulting in a stronger value proposition for customers.”
An integration team has been formed and a detailed integration plan is underway, which is expected to facilitate a smooth transition between Parker and Exotic and allow realization of synergies between the two organizations.
Exotic Metals Forming will become a stand-alone division and will continue to be led by Bill Binder, formerly Exotic President and CEO.
Binder added, “The growth opportunities Exotic will have as part of Parker are substantial. We look to the future with optimism and excitement as we leverage our combined capabilities to the benefit of our customers and team members.”
The stock is now near the upper end of resistance and could deliver a significant gain if resistance is cleared.
A Trade for Short Term Bulls
As with the ownership of any stock, buying PH 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 PH
Every day, we scan the markets looking for trades with 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 PH, the November 15 options allow a trader to gain exposure to the stock.
A November 15 $185 call option can be bought for about $4.10 and the November 15 $190 call could be sold for about $2.43. This trade would cost $1.67 to open, or $167 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 $167.
The maximum gain on the trade in PH is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in PH the maximum gain is $3.33 ($190- $185= $5; $5 – $1.67 = $3.33). This represents $333 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $167 to open this trade.
That is a potential gain of about 99% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.