PreMarket Prep: Wedbush's Michael Pachter On The Microsoft-Activision Deal And Risk Arbitrage

There are several different ways investors make money in the financial markets. One way that is not found as often in the daily headlines is risk/merger arbitrage.

This strategy attempts to profit from the narrowing of the gap in the price of a company being acquired and the acquirer's valuation of that stock in a potential takeover deal. There are several different components to the calculation that are adjusted on a daily basis. This investment strategy will be profitable if and when the deal becomes official.

Yet the multifaceted formula changes when there is an “all cash” deal on the table. Under these circumstances, the difference between the proposed takeover price and the target's actual price may indicate the amount of skepticism of the deal proposed being completed.

The Proposed Deal: The above scenario applies to Microsoft Corp's MSFT attempt to take over Activision Blizzard Inc. ATVI in an “all cash” deal at $95/share. Since the deal was announced, the latter has traded no higher than $86.90 and can be purchased in the open market around the $81.50 area as of 2 p,.m. EST on Tuesday. Obviously, there are many doubters that this deal will pass regulatory scrutiny and be approved by the FTC and the Department of Justice.

One of those not doubting that the deal comes to fruition is Michael Pachter, an entertainment, retail and software analyst at Wedbush Securities. Pachter joined the PreMarket Prep show on Tuesday to explain why he is “99.9% sure” the deal will be consummated.

The Pachter Factor: Pachter acknowledged the usual factors going into a deal, such as regulatory and inflation concerns that can make evaluation more difficult. In his opinion, “the average risk-arb fund, who is talking to a 'white shoe; law firm that is very experienced in M/A, is talking to a lawyer that has no context in the gaming industry.”

He went into detail about the “total accessible market” in the industry, which is much larger than the console market only.

Pachter added: “By year-end, the FTC comes out with a list of conditions, likely in June or July, and Microsoft is already signaling that it is willing to acquiesce to every condition. Microsoft can say 'yes or no' to the conditions. If they say 'no,' the deal gets blocked then they will have to go to court to get it approved.”

Buffett Stake: Warren Buffett’s recent stake in Activision, which was acquired before the announcement of the deal, will be scrutinized by his attorneys as well. His legal team will need to decide whether or not to hold on to the issue until maturation. Pachter stated: “Warren Buffett's lawyers are smarter than the risk-arbs lawyers, and they say this deal will get approved.”

Whether or not the deal is approved, Pachter is still bullish on Activision, with a price target above the current takeout price ($95) at $110.

The full discussion with Pachter, which covers other issues in his area of coverage can be found here.