Parlux Fragrances Revisited Using Graham's Risk-Arbitrage Formula (PARL)

With Parlux Fragrances much in the news the last few days on Chief Executive Ilia Lekach's offer to pay $29 a share to take the company private, we decided to reevaluate the current risk associated with owning shares of PARL using Graham's famous formula.

To determine optimal risk/reward in a deal, Graham used the following formula:

Annual Return = Probability the deal will go through (deal price - current price) / current price

Assuming the going private deal proposed by Lekach has only a 50% chance of working out, the formula for PARL would look like this:

50% ( (29 - 19.50)/19.50 = 24%

If you assume a 25% chance of the deal going through:

25% ( (29 - 19.50)/19.50 = 12%

The yield on the 10-yr is 5.1% and by my estimate, the yield for the S&P (based on 2007 estimates) is 7.6%. Compared to the alternatives 12% is a nice return.

Now even if the deal does not go through I believe the downside is very limited. It's currently trading at about 7x next year's earnings with an expected growth rate of 38%. This produces a PEG ratio of 0.18, making it one of the cheapest stocks on a growth basis.

It's also worth noting that the estimates used are historically conservative, because PARL continues to beat them quarter after quarter.

PARL 1-yr chart:

DISCLOSURE: I may be long the stocks mentioned above for myself and clients. This is not a recommendation to buy or sell any security.