At the annual meeting for Warren Buffett’s Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B), it was announced his firm added to its position and has a 9.5% stake in Activision Blizzard Inc. ATVI. The reason being Buffett is confident Microsoft Inc.'s MSFT offer to buy the company will be approved by regulators.
Since it has been quite some time since Buffett has dabbled in the risk arbitrage space, the topic was discussed on Monday’s PreMarket Prep Show. Mainly, the risk/reward Buffett is banking as well as the potential outcome.
Why? As of Friday’s close, Activision Blizzard was trading at a substantial discount (19.4%) to the proposed takeover price ($95 vs. $75.60). Since Buffett has built most the stake after the deal was announced, it's fair to assume his average cost is above Friday’s close.
Risk Arbs Are Hands Off: There was skepticism right from the start about whether or not the deal will pass regulatory scrutiny as the highest Activision traded during regular hours was $86.90.
Despite many analysts strongly believing the deal will go through, the risk arbs aren't so sure. As a result, Activision has fallen another $10 from the intraday high on the Jan. 16 and was $19.40 from the supposed deal price at Friday’s close. While Buffett perceives it to be “free money," much of Wall Street doesn't feel the same way.
PreMarket Prep Take: The main takeaway, as mentioned by co-host Dennis Dick, is the potential risk if the deal falls through.
As always, Dick analyzed the setup from a risk/reward perspective.
“You to look at what its peers are doing, Electronic Arts and Take-Two are getting hit hard," said Dick. “Many are assuming that if the deal does not go through, Activision will go back to $65 [the level it was at prior to the deal being announced] and the upside is $95, which is a solid risk/reward."
He concluded that if the deal falls through and under current conditions, the issue may fall to $55 or even $50.
Conclusion: “Occasionally I’ll see an arbitrage deal and do it," Buffett said during Berkshire's annual shareholder meeting. "Occasionally it looks like the odds are in our favor, but absolutely we can lose money.
"If the deal goes through, we make some money, and if the deal doesn’t go through, who knows what happens,”
Obviously, Buffett is comfortable with the risk/reward and is prepared to see it through. Investors following his lead need to decide if the risk/reward suits their investment style.
The discussion on this topic from Monday’s show can be found here:
Photo: Tarcil Tarcil from Flickr.
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