Wednesday, January 31, 2007

Well, That Was Easy Money

We learn today that US Airways has withdrawn its offer to buy Delta Airlines for what turned out to be about $9.8 billion. As I noted back in November when this madness was announced at the lower value of about $8 billion, "US Airways doesn't have it and Delta isn't worth it." For that reason, I also expected Delta's creditors to leap at the offer (and dump the US Airways stock immediately upon doing so). But here's how the deal was undone:

US Airways dropped its hostile $9.8 billion bid for Delta on Wednesday after Delta's creditors threw their support behind the airline's plan to emerge from bankruptcy on its own.

Delta Air Lines Inc.'s official unsecured creditors committee said in a statement it reached its decision after a lengthy review of both Delta's proposal and US Airways Group Inc.'s proposal.

So it was the creditors who pulled the plug after "extensive discussions." That's a surprise.

What was not a surprise was that there was money to be made here by the ordinary investor. Here's a chart of US Airways' stock price over the past three months:

That big spike in the middle of November was the roughly 16 percent increase in the stock price when the announcement was made, plus some continued appreciation. This was very unusual--the classic result from the finance literature is that upon announcement, the acquirer's stock price is either unchanged or slightly lower. It is the target's stock price that goes up. The reason, I think, is that acquirers often overpay, probably because they overstate the amount of "synergies" they'll get from the acquisition.

I could see no reason for this acquisition to be such a good thing for US Airways, so I sold short. You can see that the position was not always in the black, but eventually, it seemed pretty clear that that gain would be reversed. I managed to pocket a cool 10 percent based on when I got in and out of the position.


Anonymous said...

Selling short has always confused me.

Making money from selling short requires that you eventually buy back the stock at a lower price, correct? Would you then buy the same number of shares at that time? Or would you be buying back more shares because of the cheaper price? How is the 10% you pocketed represented - in cash, shares...?

Andrew Samwick said...

Enter Wikipedia for a reasonable definition of short selling.

In November, I sold 200 shares of US Airways that I did not own--I sold them short. My broker "borrowed" them from some other account, and I was responsible for any payments that US Airways might have made. I took the proceeds and invested them in a simple bank account that I have with my broker. In January, I bought 200 shares in the open market. This closed out my position, and my broker "repaid" these shares to the account from which they were borrowed. The 10% was the decline in the price of US Airways over that period, and I pocketed it in cash. (There was money left in the bank account after I purchased the shares to close the position.)