Why Is Merrill Lynch Trading Significantly below BAC's $29 Offer?

by: Devin Hobbes September 16, 2008 | about stocks: BAC / MER    

Devin Hobbes

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A reader sent me an email, asking me to explain to him why Merrill Lynch (MER) is trading around $19 per share when Bank of America (BAC) offered to buy MER for $29 a share. Is it the short sellers?

Well, maybe, if they're driving down BAC's share price.

The media is floating around the story that BAC offered $29 a share for MER, but this is based on BAC's closing price of $33.74 on Friday. What BAC offered was a share swap. If the deal goes through, MER shareholders will receive 0.8595 BAC shares for each of their MER shares. Therefore, for example, if you own 100 Merrill shares, if the deal goes through you'll get 85.95 Bank of America shares.

This means that MER's share price is now tied to BAC's. It's trading at a sizable discount to its implied deal value (with BAC trading at $27 and change as I was writing this post, the implied value of MER is $23 and change a share), but that's because traders aren't certain the deal will go through and there's a possibility that BAC shares will continue falling.

If you think the deal will fall apart and you own MER, consider selling your shares and buying BAC instead. Part of the reason BAC is falling is that shareholders don't like the deal. If the deal falls apart, BAC may rise. If you think the deal will go through and that BAC has bottomed, then continue holding your MER shares. In either case, you'll be getting BAC shares. The price is still up in the air.

Another way to get into BAC, which I wrote about previously, is to buy its L Series convertible preferred. They currently sport a dividend yield of around 9%.

I personally would stay away from financial stocks right now. Instead, I'll gamble with small sums on puts and calls.

Disclosure: I own Merrill puts.

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This article has 7 comments:

  •  
    Sep 16 09:32 AM
    Your last paragraph contains the best advice. This is a highly toxic industry. This deal between BAC and Merrill simply does not ring true. That's why Merrill's share price retreated to its Friday close and it's heading lower in premarket trading today. The market is saying it does not believe this deal will go ahead. It's not that stupid. God knows what Lewis is up to. Maybe he was hoping this takeover would prop the market up and prop up BAC's shareprice. Clearly that hasn't worked.
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  •  
    Sep 16 09:45 AM
    Lewis says what he means and he means what he says. I made money on the CFC takeover and people said the same things about that one. The discount was 42% when I put the trade on, and it went through without a hitch in a matter of months.

    The short sellers hate BAC because it pays fair prices for distressed companies instead of trying to drive everything to zero, and that squeezes them. But Lewis doesn't care. He has to work with the people at the companies he acquires. He treats them fairly, not like dirt. He buys at times when the market is already so distressed, BAC is getting a good price for the eventual future value of the companies he adds.

    While one of these is in progress, the arbs will short BAC. It will stay down and the professional shorts will scream and try to scuttle it. But Lewis will ignore them and do exactly what he promises. His word at six months is the same as money, in my book.

    Obviously there is a risk in all these trades. That is why they offer a return. Someone short BAC and long MER can lose on both ends if the deal fails apart. YMMV. But I consider MER an attractive way to add to my BAC position right now.
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  •  
    Sep 16 11:57 AM
    The first comment is insane. The internet should have a filter for post like that one.

    Anyway, BAC is now the biggest bank in the world and will see profits unlike any bank on earth has ever had. I would get on the train in the next 6 months. You dont have to rush in today, but after AIG, WM, and WB fail, and GS has to merge or fail, this will be the time. Jump in and enjoy the ride. You cant buy low-sell high if you buy high and sell low. It hurts, and it can be scary, but it is the only way to go.

    If GE ever dumps the sewer that is Uni/NBC and it turn the finance arm around, that is a stock with 50-75% unside as well. If BAC ran GE, GE would be a 45-55 dollar stock.
    Reply | Link to Comment
  •  
    Sep 16 07:28 PM
    Would Charlestoninvestor like to explain what is so 'insane' about the first comment. Seems reasonable to me. An emailer asked if shorts were pushing the price of BAC down. The author responded to the question.... So, what gives?

    jegan ;-)
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  •  
    Sep 17 08:30 AM
    SKF is a good insurance if you are good sailing !
    Reply | Link to Comment
  •  
    Sep 17 09:44 AM
    This morning, 9/17, Bob over CNBC mentions that, in the premarket, MER and BAC shares are not moving in sync. There must be some info of which I am not privileged to know.
    Reply | Link to Comment
  •  
    Sep 18 01:59 PM
    If you believe the deal is going through, an even better way to play is to buy MER preferreds, currently trading at a 40-50% discount. These will convert to BAC preferreds. A nice way to catch a well-protected yield of 13-14%.
    Reply | Link to Comment
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