An Opportunity to Profit from Focus Media / Sina Transaction

Focus Media Holding Limited (FMCN) has been devastated by the recent economic downturn. In late 2007, the stock topped out above $65 per share, but currently trades at roughly $7.50 - down roughly 88% from its former glory. The Chinese advertising company spent considerable capital to develop a network of outdoor advertising monitors which held promise to generate huge revenues due to exposure to the Chinese masses.

But as the economy weakened and advertisers pulled back on spending, Focus Media found itself leveraged and without the necessary revenue to keep up with expenses. Finally, the company had no choice but to sell the majority of its assets to rival Sina Corporation (SINA) in a stock deal that should close in the next few months. Focus Media will still continue to trade as a stand-alone company, but after selling its best assets, it is unclear just how the company will survive.

While the long-term concerns surrounding Focus Media are still very difficult to overlook, there is an interesting opportunity to lock in a profit from the proposed merger. Focus Media has said that it will receive 47 million shares of SINA as compensation for the outdoor advertising assets. The company plans to distribute these shares to holders of FMCN once the transaction is complete.

Focus Media has roughly 128.6 million shares outstanding and will be receiving the 47 million SINA shares to distribute. At this point it looks like each share of FMCN will have rights to 0.365 shares of SINA. So if you own 1,000 shares of FMCN you can expect to receive 365 shares of SINA. Using today’s market prices, it looks like the value of these SINA shares actually represent $10.71 for every FMCN share. However, FMCN is currently trading at just $7.60. So in theory, you could buy 1,000 shares of FMCN at the current price, short 365 shares of SINA at $29.00 and expect to make about $3.00 once the deal is complete.

Another alternative for this trade would be to buy 1,000 shares of FMCN and then sell 3 calls SINA September 30 for $2.70 If SINA trades flat to lower from current prices, you will be able to keep the premium and eventually sell your SINA shares at the market. However, if SINA trades higher, you will be obligated to sell 300 shares at $30, but you should benefit from a rise in FMCN because the payment for its transaction will be worth more.

While the transaction appears riskless on paper, one should realize that no profit comes completely free of risk. The wild card in this scenario is two-fold. First, there could be some regulatory resistance to the deal and if SINA were blocked from purchasing these assets, FMCN would likely trade even lower. It’s possible that SINA could trade higher as investors no longer fear dilution from the deal.

The second risk is that FMCN could accept the shares and then fail to distribute them to investors. While there would certainly be a large public outcry against this, it wouldn’t be the first time executives changed course mid-way through an important transaction. If FMCN were to continue to hold the SINA shares, the value would still be available to investors, but the spread could still remain wide as investors fear the company will sell the SINA shares instead of turning them out to investors. This would be bad news since Focus Media is bleeding cash without these assets and could quickly burn through the proceeds from the SINA sale.

So the opportunity to profit from this transaction is very attractive and could be a lucrative opportunity. But investors need to be aware of the risk and keep the size of this trade at a reasonable level in case the deal falls through.

Disclosure: Author does not have a position in FMCN or SINA.

Comments

[kagame:]

Absurd to think they would keep the shares. Also, the price of FMCN dropped the most dramatically AFTER the merger was announced. It had a stronger than expected quarter and gave decent guidance, things are improving for the company.

I would think FMCN is worth more without a merger, the uncertainty involved is holding the price down to near cash value. Remember FMCN has no debt, a ton of cash on hand, and assets such as ALLYES whose values are as of yet ignored by the market. Assuming some (even small or slow) global recovery is in effect and the Chinese economic stimulus is as good as it sounds, this is an absurdly cheap stock.

Especially after the afternoon sell off to $7, where we hit strong support.

Jun 22 10:56 PM

[Patrick Chu:]

I don't know how strong FMCN will continue to be after spinning off it's core business. One would think it would continue to underperform but it has been so beat down.

I think this trade could be good however. Good thinking.

Jun 23 04:11 AM

[kagame:]

Wow more manipulation. Rumors that contradict company statements issued the day before, gotta love em.

Jun 23 10:46 AM

[falanke:]

FMCN is hurt by fraud in its acquisitions. SINA is sure to discover that after completing its due diligence.

Currently, the deal is undergoing a "prolonged" regulatory approval. The truth probably is that SINA doesn't want FMCN anymore and has asked the regulators to bail them out.

If the deal doesn't happen, what's left? Well... FMCN will trade down to $5 and go lower as it's business falls apart.

Jul 27 10:49 AM