Use Arbitrage! The Tribune Company Example

December 4, 2007 by Joe Ponzio

Late last week, the FCC approved Tribune Company to own print and broadcast media in the same market. Why was this important? Tribune Company (TRB) is going private and the FCC approval was critical to this transaction. Without FCC approval, the deal might not have gone through. With that hurdle out of the way, what’s to stop it now?

And how can we make money from it?

The Details

Real estate tycoon Sam Zell is planning a buyout of Tribune Company (TRB) at the end of the year for $34 a share. Let me rephrase that-the company is expected to go private in the next 27 days and plans to buy its stock from shareholders at $34 a share.

If the deal can’t be completed by December 31st, the company will continue its quest to privatize and will begin paying shareholders an annualized 8% interest rate on their shares until the company goes private.

The Stock

The stock is currently trading around $30.50. If the deal goes through by December 31st, yesterday’s buyers will earn about 11% in a month-an annualized return of more than 265%.

The Hurdles

Very little is stopping this buyout plan now. The FCC hurdle was the major one. Though the company needs to get the deal done by the end of the month to qualify for tax credits, the paperwork seems to be in order to push the deal through no matter what.

Let’s put some probabilities on this and try to quantify the risks:

A Pabrai / Kelly Risk Analysis

What are the odds that the deal will go through by the end of the month? I’ve seen bigger deals fall through for no apparent reason other than one company couldn’t get its ass in gear. Remember GE’s planned 8 billion acquisition of one of Abbott’s divisions earlier this year? Best as I can tell, Abbott fumbled and couldn’t get the required paperwork done in time and GE pulled out.

Even though Tribune has been planning to do this deal since early this year, let’s assume that there is a 50% chance that the company will complete its buyout by December 31.

What if the company can’t get it done in the next four weeks? We know the company still wants to privatize and is offering a premium of 8% annualized if it can’t get the deal done by the end of 2007. Odds of it getting done in early to mid-2008? I’ll say 30%.

Of course, the deal can fall through and not close at all. In that case, today’s buyers would simply hold Tribune stock. Let’s say there is a nearly 20% chance of that happening.

Finally-the doomsday case. There is a small chance that the deal will fall through and that the company will fall off the face of the earth by the end of 2007. Sure, it’s a small chance. Still, we’ll ascribe a <1% chance of that happening.

Making Sense of The Odds

In this merger/buyout arbitrage play, I estimate that there is a 50% chance to make an annualized return of >265% by the end of 2007. If the deal can’t close until June of 2008, I believe that there is a 30% chance of earning 30% or greater on an annualized basis once you add in the 8% interest being paid.

I believe that there is a one in five (or 20%) chance that the deal won’t go through. In that case, I’ll hold Tribune stock, or sell it at a loss. On news of the deal failing, I’ll put that loss at 15% if I can sell around $26.

If the company goes defunct in the next 30 days, I’ll lose everything.

The Odds: How I See Them

When the odds are in your favor, bet big. I believe that the Tribune buyout presents an interesting opportunity to make a substantial amount of money in a very short timespan. It’s not guaranteed or risk-free; still, I believe that the odds are in favor of today’s buyers.

Use Arbitrage

Whether or not you buy Tribune stock today, you should consider the use of arbitrage in your investing. Whether you consider pure buyout arbitrage like we are doing with Tribune, or you are using a form of arbitrage in selling options against your positions, the use of arbitrage might make the difference between a good retirement and a great one.

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