Ways to Play Mentor Graphics

| About: Mentor Graphics (MENT)

Nearly a month has passed since Carl Icahn offered to buy Mentor Graphics (NASDAQ:MENT) in a $1.9 billion dollar deal. Icahn, who has built a near 15% stake since last year, offered $17 dollars a share to buy the company, in hopes of starting an auction for Mentor among other interested bidders. In the weeks since the bid, there have been some important changes to the story since I first wrote about it, so yesterday's response by Mentor provides for an opportunity to update investors on the situation.

On February 24th, 2 days after Mr. Icahn went public with his bid for Mentor, the company reported its full year results. Revenues were up 14% to $914.8 million, and GAAP EPS of $0.25 in fiscal year 2011, reversing a loss of $0.23 in 2010. The company's guidance for this fiscal year is for revenues to increase 9% to $1 billion, and GAAP EPS to more than triple to $0.77.

On March 10, Casablanca Capital withdrew its slate of directors to the Mentor board, and threw its weight behind Carl Icahn's nominees. Casablanca did this to "avoid shareholder confusion" and said it agreed with Mr. Icahn's efforts to encourage a Mentor sale. Casablanca made it clear that it was not actively working with Mr. Icahn, since a group of Mr. Icahn and Casablanca would own roughly 20% of Mentor, and would trigger the poison pill Mentor enacted last year. Casablanca owns a 5.5% stake in Mentor.

On March 15th, Mentor finally responded to the offer by Mr. Icahn, calling on shareholders to reject any proposals not supported by the current board of Mentor Graphics. The company cited the "outstanding results" of the year before, as well as the stock being up 70% year over year before Mr. Icahn's bid, as reasons that the current management strategy was working-- and that investors should continue to support the current board. The company also filed to update its bylaws, setting a minimum number of board members at 5, and changed the ability to alter the frequency of special meetings. The filing cites proposals made by Carl Icahn as the reason for the changes.

It appears Mentor's board is digging in its heels for a proxy battle. While I would have preferred to see Mentor agree to explore higher bids for the company, the moves are not particularly surprising. Given that Mentor was trading in the $14 and change range in the days before the $17 bid-- and are currently trading at $14.99, I think the risk / reward here is compelling. The annual meeting for Mentor is scheduled for May 12, so that will be the next key date to watch, barring any news of new bids, or a change in strategy by either party.

Aggressive investors could look to buy a $15-$17.50 July call spread for about $0.85. Break even would be $15.85 at July expiration, the maximum payout would be $2.50, and would only be realized if a bid above $17.50 is made in the next few months. The options in the name do have rather large bid / ask spreads, so limit orders are a must here. Less aggressive investors could simply buy the stock, hoping for either a narrowing of the 13% spread between where the stock is now and the bid, or for a higher bid.

Disclosure: I am long MENT.

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