By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
Some of my best (and worst) stock market ideas came from trading the merger/arbitrage, event driven/catalyst grapevine on Wall Street, listening to the hoofbeats of the ultimate smart money/hedge fund herds in the deal business. We caught the 50% move in 20th Century Fox before and after the House of Mouse made an offer for the House of Murdoch’s crown jewels in Fox. Then we published an article recommending the accumulation of the Magic Kingdom (Disney) at 100 for our post deal close target of 135. Disney now trades at 146.26 as I write.
I shorted Occidental Petroleum after CEO Vicky Holub loaded the oil and gas empire created by Dr. Armand Hammer, a legendary wildcatter who dealt with every Soviet leader from Lenin to Gorbachev, in a desperate attempt to spoil Chevron’s takeover bid for Anadarko. Another idea? I positioned for the CBS and Viacom merger under Shari Redstone’s handpicked CEO Bob Bakish in August but lost money as Wall Street dissed the terms of the merger, its upfront cost synergies potential, the scale of cord cutting at Viacom (Nickelodeon, MTV) and the turnaround prospects of its Hollywood movie studio Paramount Pictures. I published this idea too in this media platform and newspaper columns.
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Yet despite a 18% drop in CBS shares after the merger was announced, I did not sell as I passionately believe the merged company Viacom CBS (symbol VIAC) is now the world’s most undervalued, unloved, misunderstood content generation machine – and content is king in the Digital Age. I hope my faith in this damp squid media merger will payoff big time. Since last week, Viacom CBS shares suddenly surged from 36 to above 41 on rising volume and breached their 20 day moving average. This spells accumulation to me. Funny how the heart plays the games on the mind when a white hot deal stock goes ballistic on the NYSE. My deepest emotional hopes and cerebral conviction calls now merge when I am underwater in a hot deal stock that has began to rock the tape and flutter my heart. So I did exactly what my mentors in Manhattan told me not to do – when in trouble, double! Somebody, somewhere is accumulating Viacom CBS and the merger arbs are agog since they sense a chance to make rain while the world shuts down for Christmas parties. Who’s gonna be my Santa for Viacom CBS at 41 or 8 times earnings?
My friends in New York tell me Apple desperately needs a content generation empire – TV, movies, news, syndicated media, the legendary CBS News, Showtime, the Hollywood movie studios and streaming media. This is self-explanatory to me. Apple is valued at $1.2 trillion so its shares are super-currency while Viacom CBS is a itsy bitsy $23 billion modest media empire with much to be modest about, akin to Churchill’s verdict on his nemesis Clem Atlee. Will Apple make a bid for Viacom CBS? No idea, but if it does, Shari Redstone, who controls the fate of this media puppy with her unassailable family stake in National Amusements, will demand the mother of all takeover bid premiums. If Tim Cook really covets this media prize, he will gladly pay this huge premium in a stock/cash bid. So I watch and wait and do my own accumulation of Viacom CBS… the tape is my only Zeus/Jupiter in my investing life’s Mount Olympus (the NYSE!). What is my next target on Viacom CBS – 45-46. The trend is your friend until the trend comes to an end – or Apple, Amazon or some other tech/media Godzilla makes a move on the House That Sumner Built.
Another money making deal stock idea? DuPont de Nemours (symbol DD on the NYSE). I was aghast at the Dow Chemical merger and so missed the ghastly 45% stock price plunge in DuPont shares in 2018-19. Yet management has shown resolve in transforming the chemical conglomerate built by one of America’s most blue blood Gallic clans, once the lords of Delware. One, DuPont exited Dow Chemicals (commodity chemicals? Ugh!). Two, it spun off its agribusiness division Corteva. Three, DuPont is selling its nutrition and bioscience business to International Flavors & Fragrances (IFF) in a $26 billion deal where DuPont shareholders will own 55% of the post deal company.
My take? The alchemy of finance, as George Soros called it, begins to work its magic on the leaner, meaner (50% of the pre-deal market cap gone), higher margin DuPont. This is the eureka moment/Achtung Baby/Gotcha insight in a complex deal stock for me… the catalyst that evokes that Prince Charming will kiss the Sleeping Beauty, that Cinderella and not her two Ugly Stepsisters will go to the fairy tale ball hosted by a handsome Prince with a foot fetish. DuPont’s core operating margins will surge in 2020. The cash hoard has spiked and spells a dividend increase/board approval for a accelerated shareholder buyback program for me. The special cash payback from the IFF deal alone is $7.5 billion, yum yum gimme some time for shareholders.
DuPont is a beneficiary of the hottest secular trends of the Roaring Twenties (alas, this time without Scott, Zelda, Dali, Picasso, Papa and the old Rive Gauche lost generation crowd). Electric cars, robotics, 5G networks, 3D printing, green energy, Next Gen construction, smart cities/smart grids. So all DuPont post deal core businesses will exhibit higher EPS growth, higher operating margins and bigger global growth market footprints. This is the perfect macro milieu for a valuation rerating that is simply not priced into the stock.
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Risks? Break risk on the IFF deal as the legal Gestapo/ Beltway lobbyists of Washington can make the best laid plans of mice and men and Big Board CEO’s aft go astray. I am also worried about the hit China and India’s shadow banking/systemic debt woes will have on global economic growth swoons in 2020. If this happens, DuPont stock is toast but then so is the global financial village. Will I commit capital to DuPont shares now? Yes – even though, as the awful old Salt N Peppa song from the 1990’s went, let’s talk about risk baby, let’s talk about you and me, let’s talk about all the good things and bad things that can be, let talk about risk…
Yet I can calculate the impact of the deal/macro risk on DuPont and thus hedge/risk manage it. So yo, Uncle Scrooge! DuPont is trading at 10.8 times forward earnings and Mr. Market has not repriced that 2020 is going to let the good times roll. So, is it boogie wonderland for this post deal puppy in 2020 as long as the wicked witch of Wall Street does not pull another intercontinental emerging market debt contagion/meltdown on us? Time to buy just now at 63? Not yet. I want to structure a buy at 56 via the Chicago CBOE option market and also hedge downside IFF deal break risk. Then and only then will I feel safe to watch the Street rerate DuPont (DD). As I learnt so long ago at Penn, no guts, no glory and no guts, no gori!