Activision Calls Could Pop But…
Contributor since 2012 / 36909 Followers
Summary:
- Where do you put money that you need?
- I have some big upcoming checks to write.
- Here are ideas for protecting earmarked principal.
David Becker
Activision
My Activision Blizzard, Inc. (NASDAQ:ATVI) calls will be fantastic if the FTC loses to Microsoft Corporation (NASDAQ:MSFT) in their goofy antitrust suit. I own them for a reason – not only do I expect Microsoft to win, but to abruptly consummate the deal before next month’s walk date or risk Activision demanding a bump to the deal price. I’d ask for $110 per share. But if I’m wrong on any part of this, then the calls are $0s.
For more on ATVI: Chris DeMuth’s State of the Markets June 2023
The downside of multi-bagger candidates
The flipside of potential multi-baggers is that they’re also potential $0s. Innovate Corp.’s (VATE) Medibeacon alone could be worth more than the company’s entire market cap; if it is a hit, it could drive the share price from under $2 to double digits. But it is a highly leveraged equity that could be worthless if they miss bond payments. My falsifiable thesis is that they won’t. However, the bond price indicates a real chance that I’m simply wrong. They last traded at a yield of about 20%. I love both ATVI calls and VATE, but love them sized so that it wouldn’t ruin my day if they go to $0. In these cases, it is reasonably likely that you won’t get any of your money back. Whether or not I own something is a matter of expected value, but sizing is based on downside.
Or your money back!
As for money that I need, earmarked for a few big demutualization investments in the medium term and a few big real estate projects in the longer term, I want far more principal protection. I forego potential multi-bagger upside for the confidence that I’ll still have money that I know I’ll need. Where do I look for ways to put money to work where I’ll get back most or all of my principal?
Special purpose acquisition companies
SPAC IPOs or SPACs trading at a discount to their cash in trust before their redemption deadlines are great places for principal protection. AltC Acquisition Corp. (ALCC) IPOed at $10 (as with demutualizations, they’re usually set at $10). I can redeem it for around $10.28 per share in cash or sell it in the market for a current price of $10.54 or wait to see if they find a way to supply the limitless demand for AI-themed investments with a deal that causes the price to roar. Sam Altman, CEO of OpenAI, is AltC’s executive officer and director. The upside is highly speculative but the downside from the last price is certain and limited. The downside from the IPO was certain and zero (or limited to opportunity cost only).
Merger arbitrage
Merger arb can offer principal protection as well. I own a substantial stake in Chinook Therapeutics (KDNY) which is in the process of getting bought by Novartis (NVS). The deal requires HSR antitrust approval as well as KDNY shareholder approval. There are no legitimate antitrust problems as KDNY doesn’t directly overlap with NVS’ kidney portfolio. The premium should justify shareholder approval. If they secure antitrust and shareholder approvals, then KDNY shareholders get $40 in cash and a contingent value right. Each CVR represents the right to get $2 if the FDA approves a new drug application for atrasentan for the treatment of Immunoglobulin A nephropathy, which approval does not impose a risk evaluation and mitigation strategy that is related to liver toxicity, on or before December 31, 2025. We get another $2 if the FDA approves a new drug application for atrasentan for the treatment of focal segmental glomerulosclerosis on or before December 31, 2029. What is the CVR worth? In the proxy, the financial analysis put an NPV at $1.87:
For analytical purposes, Centerview calculated an illustrative risk-adjusted net present value for CVR of $1.87, assuming that CVR holders receive a gross payment of $4.00 per one CVR upon the achievement of the Milestones, which was risk-adjusted based solely on the assessments of Chinook management as to the probability and the timing of achievement of the Milestones and realizing the Milestone Payments, and was discounted to present value as of June 30, 2023 using a discount rate of 12.5% (based on the midpoint of the range suggested by Centerview’s analysis of Chinook’s weighted average cost of capital).
I’d take the under for reasons consistent with Muddy Waters’ views expressed in this and this report and well as this video. It is always worth studying and understanding the short thesis on anything you own and in particular with a merger arbitrage target with a capped upside from here. But KDNY trades beneath the cash component of the deal consideration. So we get a 10% IRR between now and November if the $1.41 net spread closes by then. For a certain and capped downside, one can simply wait until after such deals are unconditional but before the shares are delisted; at that point you can know that you’ll get between $40 and $44.
Federal Deposit Insurance Corporation
FDIC (and other federal insurance) is the ultimate in principal protection. American First Credit Union offers a 5.15% APY and $250k of federal deposit insurance. GreenState Credit Union has a 10-month 5.3% APY certificate. For upcoming investments that I’ll need to pull money for earlier, I like the no penalty 5-month 5.06% CD from Technology Credit Union. Each has additional potential upsides if they subsequently convert to banks and each are conveniently available on the Raisin platform.
By far my favorite savings account is the Save Market Savings – I don’t have anything else like it. It combines federal insurance for total principal protection, tax efficiency, market-linked APY that could be twice that of other principal protected accounts if markets perform well, and a sign up bonus kicker that offers 6x the return on the first $1k deposit.
Conclusion
Leveraged equity and calls are for upside optionality and need to be sized accordingly. For money that you count on, focus on downside protection. You can find it in the cash merger consideration in definitive and unconditional deals, SPACs before redemption deadlines, and – best of all – federal deposit insurance.
TL; DR
Never bet more than you can lose.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of ATVI, VATE, KDNY, ALCC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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