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This Merger Could Lead to a Triple Digit Gain

This Merger Could Lead to a Triple Digit Gain

When deals are announced, prices often jump but speculation about a deal could offer traders a chance to benefit from the announcement. This can be risky so risk management strategies should be considered.

An example of this idea can be found in the recent story on Bloomberg that reported, “Global Payments Inc. is nearing an all-stock deal to buy Total System Services Inc. (NYSE: TSS)  for about $20 billion, according to a person familiar with the matter, in what would be the third mega-merger in the payments industry this year.

The companies are preparing to announce a transaction [soon], said the person, who asked not to be identified because the matter isn’t public. The companies had also discussed possible joint ventures and other ways to partner up, people with knowledge of the talks said earlier.

No deal has been finalized and talks could fall apart, the people said.

A representative for Global Payments declined to comment, while a Total System Services representative didn’t respond to requests for comment.

Market watchers have pegged Global Payments and Total System Services as potential takeover targets or merger partners in the wake of two jumbo payments deals. Fidelity National Services Inc. struck a $34 billion deal for Worldpay Inc. in March, two months after Fiserv Inc. agreed to buy First Data Corp. for $22 billion.

“We are not surprised that two of the larger players left standing are contemplating their options, including a potential tie-up,” Steven Kwok, an analyst with Keefe, Bruyette & Woods Inc., said in a research note Friday. “We think there are multiple options that may make sense — merger, JV, partnership.”

Payments firms are pairing up to diversify and grow as consumers increasingly shy away from using cash to make purchases. While this year’s merger wave in the payments industry might have exhausted the prospect for many more mega-deals, Total System Services and Global Payments could still be the exceptions, Bloomberg Intelligence analyst David Ritter has said.

Global Payments and Total System Services have complementary businesses, as they focus on different parts of the payments ecosystem. Coming together would enable them to create a network that serves and connects financial institutions and merchants, similar to the offerings of Visa Inc. and Mastercard Inc.

Together they could potentially bypass payment networks by routing debit transactions from merchants directly to banking systems, which would be a “big prize,” Moshe Katri, an analyst at Wedbush Securities Inc., said in a research note.

Total System Services, based in Columbus, Georgia, is the largest third-party processor for credit-card issuers in the U.S., servicing about 40% of the domestic card accounts of both Visa and Mastercard last year, according to its annual report. Led by Chief Executive Officer Troy Woods, it has made several acquisitions on his watch, including the $2.4 billion purchase of TransFirst Inc. in 2016.

Global Payments is the fifth-biggest merchant acquirer in the U.S., according to a report in March from the Nilson Report, an industry trade publication. Merchant acquirers are financial institutions that help businesses handle credit and debit card payments, among other transaction services.

Global Payments CEO Jeff Sloan — a former Goldman Sachs Group Inc. investment banker — is a serial dealmaker. His company has pursued almost a dozen acquisitions since he took the helm in 2013, including a $4.3 billion deal for Heartland Payment Systems Inc.

TSS has been in a trading range recently.

TSS daily chart

That range comes near an important resistance level.

TSS weekly chart

A Trade for Short Term Bulls

As with the ownership of any stock, buying TSS 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.

bull call spread

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 TSS

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 TSS, the August 16 options allow a trader to gain exposure to the stock.

An August 16 $115 call option can be bought for about $4.12 and the August 16 $120 call could be sold for about $2.14. This trade would cost $1.98 to open, or $198 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 $198

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 TSS the maximum gain is $3.02 ($120 – $115= $5; $5 – $1.98 = $3.02). This represents $302 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $198 to open this trade.

That is a potential gain of about 152% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.