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Arbitrage Spread Big Enough to Play in CAPS

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December 21, 2011 – Comments (5) | RELATED TICKERS: VRUS.DL , ARB.DL , SPRD

In most acquisition deals, the spread between the current stock price and the deal price is too narrow to make a CAPS play.  However, I stumbled across one while researching a recent bond article that has a big enough spread make the play interesting in CAPS.

The company is Pharmasset (VRUS).  It's a clinical stage pharma company, meaning it has some products in the pipeline, but nothing on the market generating revenue.

On a business operations basis, this isn't the type of company I'd be interested in - way outside my risk comfort zone.  However, the play here has nothing to do with the business operations.  VRUS closed today at $125.30.  Gilead (GILD) has offered to buy the company for $137 per share. 

A 9% spread is big enough for a CAPS pick to work out as long as:
a) the deal doesn't fall apart and
b) SPY doesn't go up by more than the spread before the deal closes
c) if SPY is up less than 4%, it'll count toward accuracy.

This isn't risk-free points.  VRUS was trading in the low $70's before the deal was announced and it's reasonable to assume it would head back to those levels if something happened to squash the buyout.  But, Gilead has already sold bonds to raise money for the deal - doesn't mean it's a done deal, but it's a step in that direction.

I made the CAPS pick a few days ago and am currently a little in the hole with it.

I'm also thinking about a small real-money dice roll on this.  Since I'm a Fool contributing writer, the disclosure policy means I have to wait at least two business days before I can make a trade in VRUS after writing about it in an article, blog or on the boards.  Bonus for me is that gives me two days to come to my senses before doing something stupid.

Not responsible for lost CAPS points if you follow my lead in the game or lost dollars if you make the real life gamble.

In case you missed it, I'm trying my own mini-Foolanthropy and am chipping in to charity for comments to my blogs or articles this week.  Details here.  Please feel free to help spend my money or join in and issue your own giving challenge.

Disclosure: No position in any company mentioned.

Fool on!

Russ

5 Comments – Post Your Own

#1) On December 22, 2011 at 12:17 AM, zzlangerhans (99.69) wrote:

Be very careful. After the deal was announced, Pharmasset reported they would be discontinuing treatment with hepatitis C candidate PSI-938 in a clinical trial due to the development of elevated liver function tests. The company's most valuable compound, PSI-7977, does not seem to be affected by this and both Pharmasset and Gilead have reaffirmed that the merger would proceed.

Many people believe Gilead has overpaid for Pharmasset and might be prone to second thoughts, which is what accounts for your "arbitrage" differential. The odds are likely over 90% that you are correct and the buyout will be completed. If something does turn out to be wrong with PSI-7977 which kills the buyout, Pharmasset will lose 90% of its value overnight.

Not my cup of tea. 

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#2) On December 22, 2011 at 2:04 AM, ikkyu2 (99.32) wrote:

Yeah, I think it's tough to really remember the reality of these 'clinical stage' companies, which own things that may have no value, and if they own something that turns out to have value, they have to turn to Big Pharma to monetize it and extract the value.

Valuing the assets of a company like that is really tough.  I have owned more than one of these spec bios that had very promising stuff, but eventually concerns about safety, lack of efficacy, lack of superiority, lack of non-inferiority, or lack of marketability meant that the stock went to zero.  I eventually got tired of "stock goes to zero" and got out of this particular game.

Have spent a few years on the clinical end of clinical trials too, and my goodness, that certainly did nothing to inspire confidence.

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#3) On December 22, 2011 at 2:19 AM, portefeuille (99.59) wrote:

I eventually got tired of "stock goes to zero" and got out of this particular game.

diversification should take care of those ...

http://caps.fool.com/player/zzlangerhans/sectors.aspx?astable=biotechnology&filter=all#biotechnology

http://caps.fool.com/player/portefeuille/sectors.aspx?astable=biotechnology&filter=all#biotechnology

http://caps.fool.com/player/portefeuille2/sectors.aspx?astable=biotechnology&filter=all#biotechnology

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#4) On December 22, 2011 at 12:23 PM, leohaas (32.18) wrote:

Nice find! I think this is worth pursuing, both in CAPS and with real money.

"On a business operations basis, this isn't the type of company I'd be interested in - way outside my risk comfort zone."

You are answering you own question ("I'm also thinking about a small real-money dice roll on this") here. If you are not comfortable holding this kind of risky company, then playing the arbitrage game on it is not for you: after all, you'd be playing a risky game on a risky company.

Good luck any way you decide!

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#5) On December 22, 2011 at 6:50 PM, rd80 (98.50) wrote:

This is one of the things I like about these blogs.  Put an idea out there and some smart Fools are likely to come along and fill in more pieces of the puzzle.

Thanks for the comments.

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