A great example of a free option: Loblaws

Brandon Snow's picture

Everyone is talking about the big news this week, Loblaws buying Shoppers, but the market is offering another opportunity to benefit from the deal.

Loblaws it currently trading at $48.50, up $1 from where it was prior to the announcement. There are only two possible outcomes: Either the deal goes through or it doesn't.

If the deal goes through (very high probability): The company has already said it is 10%+ accretive to earnings year one, which is much higher than the stock performance (+2.5%) since. Beyond this rough cut accretion there are addition synergies potential on the cost and revenue side, and further benefits over time for the Choice Properties REIT with two potential anchor tenants.

If the deal does not go through: This scenario would most likely be due to a competing bid. In that case Loblaws would get their break fee of $300m (roughly $1/shr), which when added to the stock price prior to the deal gets you to the current market price.

So, if the deal does not go through - you are no worse off owning Loblaws than you were prior to the announcement and if it does go through - you are getting 10%+ upside through synergies upon integration. We always talk about free options when investing: this is a great example.

Why isn't the stock reflecting the reality? For one, a lot of the trading since the deal has been arbitrage players, people looking at the next 3-6 months for a return rather than seeing the long-term picture. Second, Loblaws already made a significant value creating move this year and it's likely people already are invested. Fear of being too far off the benchmark, or having too much exposure to one name will keep them from adding. Finally, in general many sell side analysts are incremental in their target price adjustment, with this being especially true in "boring" sectors like consumer staples. Add it all up and the market is once again showing it is not always efficient, to our collective advantage.

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