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Viterra Bid – Success or Failure?

Richard Croft
May 29, 2011
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4 minutes read
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Rumors are swirling about Canadian agri-business Viterra Inc. (TSX: VT, Friday’s close $12.04) possibly bidding for the major Australian grain handler GrainCorp Ltd. Viterra is already a big player in Australia, and the $1.89 billion acquisition would expand Viterra’s footprint in the all-important Asian grain market.

Does Viterra have a real chance of acquiring GrainCorp? There are other players sniffing around, including Archer Daniels Midland Co., Bunge Ltd., and Singapore’s Noble Group. Not to mention, the possibility that the Australian government might hold a grudge over last year’s federal government rejection of Australian miner BHP Billiton’s hostile takeover bid for Potash Corp. of Saskatchewan. It’s probably 50-50 at best!

For the moment, and I have no information one way or the other, let’s assume that VT is not successful. The shares spiked higher in January, from a starting point of $9.50 per share. But since then, despite last weeks volatility, VT has been range bound between $11 and $12.

Assuming the company is not able to make the acquisition the downside is probably somewhere south of $10 per share. That’s about where the stock was in January.

Even a successful deal will take time. The devil to any deal being in the details. Lawyers and management will work through details and until that gets resolved, VT probably remains range bound. Say an upside target at the top end of its recent trading range (i.e. $12 per share).

Assuming a range bound outcome, keeping with our 50-50 theme and given VT options trading at 31% implied volatility, one can make a case for covered call writing. Certainly as a strategy to play this story through the summer months.

With VT at $12.04 per share, you might look at buying the shares and writing the July 12 calls at 50 cents (bid price), or the October 12 calls at 95 cents. The return if the stock remains unchanged or is called away is 3.9% through July or 8.2% through October. Your downside break even is $11.34 using the July options, or $10.94 with the October calls.

A more aggressive approach if you believe the bid fails, is a bear call spread. In this case, you would sell an in-the-money call and buy an out-of-the-money call to hedge your risk. Look at selling the July 10 calls at $2.05 and buying the July 12 calls at 55 cents (offered price).

The net credit on this trade is $1.50 per share ($2.05 credit from the sale of the July 10 calls less the 55 cent cost of the July 12 calls), which is your maximum potential profit. Should the stock be trading below $10 per share at the July expiration, both option would expire worthless, and you would retain the net credit.

The maximum risk occurs if the stock is above $12 per share at the July expiration. In that case, you would lose $2.00 per share less the initial credit of $1.50 for the maximum exposure of 50 cents per share.

The most aggressive position is the long put strategy. It is more aggressive because it is not a credit position and timing is critical. If you think the deal fails and expect that to occur soon, VT probably falls back below $11 per share. Buying the VT July 12 puts at 50 cents would be one way to play the outcome aggressively.

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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