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Radware (NASDAQ:RDWR) caught my attention midday Tuesday, as networking specialist technology company jumped almost 38% in a matter of a few minutes. The cause of this rise derived from a report from an Israeli financial newspaper called Globes. Referencing unnamed sources, the article stated that Radware is close to being acquired by either IBM (NYSE:IBM) or Hewlett Packard (NYSE:HPQ). The value of this buyout is reported to be $945 million, or roughly 45/share. Of course Radware, HP, as well as IBM all declined to comment. Thus, this is only a rumor. No other news sources have provided independent confirmation of a deal. But the thought of yet another technology acquisition had me intrigued and looking for ways to cash in.

At this point, the truth behind this rumor is anyone’s guess. Although from a practical standpoint, I do not see much synergy with Hewlett Packard. However, the CEO-less company has been on quite the buying binge lately so I cannot rule them out. As for IBM, Radware appears to better align with the company’s core business strategy. Furthermore, per Radware’s website, the company and IBM already have a good relationship “…based upon long-standing and successful joint field engagements…” For instance, in 2006 the companies penned an agreement allowing IBM to resell Radware products and services globally. The collaboration has only intensified since. Radware notes that this ongoing collaboration creates a

…close partnership where Radware and [IBM] can provide their mutual global customers with bundled, best-of-breed technology and services solutions from market-leading organizations.

To fuel speculation, analysts covering Radware have recently noted the clear trends toward consolidation in the industry. In fact, just a few days ago, Oppenheimer analysts commented that the company could be acquired for its IP and raised the share's target price from $26 to $30.

So how does one play such a rumor for profit? I have provided a simple risk analysis to show two likely scenarios and to demonstrate why caution may be wise here.

Risk Analysis:

It seems a pretty safe assumption that if the rumor turns out to be false or a deal falls through, the stock price will return to normal or near normal levels. Before the Globes article was published, the company was trading at ~$28/share. If the rumor proves accurate, Radware will be acquired for about $945 million. This puts the stock trading at or near $45/share. Monday’s closing price was about $38. Simplifying things, this leaves us with two basic outcomes:

1. Buyout occurs: Stock price + $7 or 18.4%

2. False Rumor/No Deal: Stock price - $10 or -26.3%

So far, only one report has been cited regarding a Radware and a IBM/HP deal. Many news agencies and tech blogs followed up on the rumor but none was able to provide any further evidence, only citing the original article. Therefore, at this point, it is safe to say the chances of a deal are 50-50. Our risk analysis makes this an 18% gain versus the potential 26% loss. Assuming both scenarios having an equal likelihood of occurring, it would be wise to stay away from buying this stock at these levels, as the larger potential loss from this trade is greater than the gain.

However, if you find the rumor credible, or perhaps have some spare cash on the side you wouldn’t mind risking, one could throw some money in at these levels. It could very well result in a nice, quick profit if a deal does indeed materialize. Keep in mind though that this model is simplified. It is based off the assumptions detailed in the Globes article and the likely stock price outcomes. A whole host of scenarios could occur; from a much lower buyout offer to a ‘3Par (NYSE:PAR) -like’ bidding war. For me though, I will watch this drama from the sidelines. As alluring as the exciting M&A story and the potential quick profit are, the risk at these levels is just too great to get involved.

Disclosure: N/A

Source: Radware: Avoiding the Allure of (Another) M&A Story