Terminal Troubles

Richard Croft
February 13, 2012
7 minutes read

Thomson Reuters Corp. (TSX: TRI, Friday’s close $26.66) is the giant global data and information company that was once headquartered in Canada, and now resides in New York. It’s known in the financial services business for its dedicated Eikon data terminals, which supply all manner of real-time market data and research to analysts, traders, and brokers around the world. It’s also well known for its Reuters newswire feed, as well as its legal, tax, and accounting publication divisions.

With all that intellectual property at its command, you’d think TRI would have done a better job of managing itself to better and bigger growth over the past five years or so. But this hasn’t been the case. It’s almost as if the company has been unable to parlay its early digital advantages (it was one of the first in electronic distribution of information) into a larger market share over later competitors like Bloomberg Inc. Instead, Thomson Reuters has been displaying all the signs of a vegetarian dinosaur stuck in the tar pits, as smarter, faster, nimbler and far more predatory competitors lick their chops in anticipation of a fine meal.

Thomson Reuters reported a fourth-quarter loss of $2.57 billion ($3.11 per share), following a one-time $3 billion goodwill write down. The company has struggled to digest its $17 billion acquisition of Reuters Group PLC in 2008. And its Markets division, which accounts for half of the company’s $13 billion annual revenue, hasn’t performed to expectations, as its Eikon data terminal product has failed to make significant inroads against Bloomberg’s dominant market footprint.

Thomson Reuters’ disappointing fourth-quarter earnings results are simply the latest in a long string of flaccid earnings over the past five years. As a result, share price has been falling steadily, from a high of over $50 in February 2007, to a recent $26, very near its October 2008 low.

The company is busy reorganizing and selling divisions and paring costs in an effort to turn things around, but the question remains whether it will be able to turn around its key revenue driver, the Markets division, which is laboring to sell the Eikon desktop terminals to a financial industry that seems smitten with the Bloomberg terminals (15,000 Eikon terminals in use versus 300,000 Bloombergs).

This is a tough row to hoe – as beleaguered Canadian smartphone company Research-in-Motion Ltd. (TSX: RIM) can attest. Even a long-term successful company can hit a rough patch…or worse.

However, unlike RIM that does not pay a dividend, TRI has been paying a dividend for some time and currently yields 4.82%. Certainly that yield, if the market believes it is sustainable, will provide some downside protection.

For options traders who believe that there may still be more bad news – and lower share prices – to come, the natural tendency would be to buy put options. Especially medium term positions expiring say in August. Certainly the options are relatively inexpensive with implied volatilities around 20%, in the third quartile of all Canadian option premiums. But if the market perceives that the dividend is safe, you have to question the extent of any significant downside from here.

With that in mind, you could look at bear call credit spreads or bear put debit spreads. The first strategy involves selling a close to the money call and then buying another call at a higher strike. In order for this position to meet the definition of a spread and thus take advantage of the advantageous margin requirements associated with spreads, the call you buy must expire at the same time or later than the call you sell.

As an example look at selling the TRI August 27 calls at $1.25 while buying the August 32 calls at 15 cents. This spread nets you a credit of $1.10 per share. If TRI is below $27 per share at the August expiration, you will retain the net credit which is your maximum potential gain. The advantage of this strategy is that TRI does not have to decline further for you to make your maximum potential gain. If it stays at current levels, it would still be trading below $27 per share and you would earn your maximum return.

The worst case scenario would see TRI rally above $32 per share at which point any losses associated with the short August 27 call would be offset by gains in the long August 32 calls. The maximum risk then is the difference in strike prices ($32 less $27 = $5.00 per share) less the net credit received ($1.10) which equals $3.90.

The bull put spread is a debit spread where you typically buy a close to the money put and sell an out-of-the-money put. In this case, you could buy the TRI August 26 puts at $1.80 and sell the August 22 puts at 50 cents. The net cost for this spread is $1.30 (i.e. $1.80 less 50 cents = $1.30) which is your maximum risk. Since you are paying the net up front cost there is no margin requirement.

Unlike the bear call spread example, the underlying shares have to decline in order for this trade to be profitable. At expiration TRI would have to be trading below $24.70 per share ($26 strike pride less $1.30 net debit = $24.70 break even price) for this trade to be profitable.

The maximum potential from this trade would occur if TRI is trading below $22 per share at the August expiration. At a price below $22 per share, any further gains on the August 26 put would be offset by losses on the August 22 put. The maximum potential return then is $2.70 per spread which is the difference in strike prices ($26 less $22 = $4.00 per share) less the net debit ($1.30) to establish the position.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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