Takeovers and takeover rumors can fuel large stock moves, often
with the company being acquired going up and the company completing
theacquisition falling.
These price moves are logical. Takeover targets tend to be
undervalued and thebuyout is usually done at a price above
themarket price . After the deal, it takes time to integrate the
two companies and the acquirer could see short-term costs as they
build a stronger business. While the stock price of the acquirer
might move higher over years, in the short term, it often
falls.
However, takeoverspeculation surrounding Hostess Brands has
actually caused the stock price of potential buyer
Flower Foods (
FLO
)
to gain more than 30%.
Hostess, the maker of Twinkies and other snack foods, has been
in bankruptcy.Liquidation seems likely and Hostess doesoffer an
attractive group of brands along with a large baking and
distribution network. If the brands could be bought at the right
price and integrated effectively alongside Flower Foods brands,
this could be a good deal. However, those are two big "ifs."
There seems to be a bidding war developing for Hostess, which
could make Twinkies and the other brands more expensive than they
should be. Several other large companies believe they can complete
aturnaround and create profits from the brands and distribution
channels developed by Hostess. Bidding wars can lead a company to
pay too much and overpaying could diminish the potential profits.
Because there are so many questions associated with Hostess, the
profits could be difficult to obtain no matter what the buyer
pays.
Given all the uncertainty, it seems difficult to explain why
Flower Foods is up so much. The price is above its upper Bollinger
Band on the weekly chart. We should expect to see a break of the
upper Band about 2.5% of the time, so this is an indication that
the recent price activity is unusual.
A classic case of "buy the rumor, sell the news" seems likely
here. If Flower Foods wins a bidding war for Hostess, traders will
likely sell as they consider the reality that management will need
time to integrate the struggling company. If Flower Foods loses the
bidding, traders will refocus on valuation and see that the stock
is potentiallyovervalued .
After the recent price surge, Flower Foods is trading at more
than 26 timesearnings . Analysts expect earnings growth of 3% this
year and an average of about 8% over the next five years. A Hostess
acquisition would change those estimates, but Flower Foods would
probably have to increase their debt and face higher interest
expenses in addition to business integration costs, which could
lower earnings. It is difficult to see how the acquisition could
grow earnings fast enough to support the lofty price-to-earnings
(P/E ) ratio Flower Foods has reached.
Flower Foods is a great short trade candidate, but thedividend
would make a short trade expensive since you will be liable for
dividend payments on ashort sale . Put options seem like the best
way to take advantage of this opportunity. After the Hostess sale
is completed by the bankruptcy court, Flower Foods is likely to
fall toward the lower Bollinger Band, which establishes aprice
target near $18.25.
April put options with astrike price of $22.50 are trading at
about $1.35. These options would be profitable if Flower Foods
falls below $21.15, about 8% below the recent price. With five
months toexpiration , it seems very likely that traders will
reevaluate the Hostess takeover potential. If there is a sell-off
in Flower Foods, these options offer a low-cost way to
participate.
Action to Take -->
Buy Flower Foods April 22.50 Puts at $1.50 or less. Set stop-loss
at $0.50. Set price target at $3 for a potential 100% gain in five
months.
This article originally appeared on TradingAuthority.com:
Traders Could Make 100% Betting Against This
Potential Twinkie Savior