Let me cut to the chase: Microchip maker Cypress Semiconductor (NASDAQ: CY) is a buy if you're happy to pocket an 8% return by the end of 2019. There ain't no such thing as a sure bet, but I'm 90% sure that this is what owning Cypress shares will do for you.
You see, the company is in the process of being acquired by German peer Infineon Technologies (NASDAQOTH: IFNNY). The Germans most definitely think that Cypress is a buy to the tune of $23.85 per share. Cypress shares are trading roughly 8% below that level today, which gives the stock a near-certain target price.
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This is a clean example of merger arbitrage. Cypress has a solid buyout offer on the table, an all-cash affair that is expected to close near the end of 2019 or early 2020. We have a fixed price point, a well-defined closing window, and an opportunity to collect the resulting 8% return in a span of roughly six to seven months.
Buying Cypress today is a bet on two distinct events:
- The merger will close as expected, and
- 8% will be a reasonable seven-month return compared to other investment opportunities.
The stock is trading this far below the promised buyout price because some investors worry about outside forces blocking the buyout. Those fears will either be proven correct or subside over time. Mergers do fall apart every now and then -- recall Qualcomm's (NASDAQ: QCOM) bid to acquire NXP Semiconductors (NASDAQ: NXPI) petering out after nearly two years of regulatory reviews. In that light, it makes sense to leave some room for risk insurance in Cypress' share price.
All of this is standard operating procedure for mergers that have any chance at all of failing. Patient investors can make a little money by accepting a little risk, with the understanding that a certain percentage of proposed deals end up collapsing and erasing the buyout premium in a hurry.
Why the Cypress-Infineon deal should work out
Like the proposed Qualcomm/NXP merger, this deal involves one American and one European chip maker. All of these companies often butt heads in shared target markets such as the Internet of Things and automotive computing. At first glance, it seems like whatever happened to NXP could very well apply to Cypress as well.
But there are also some key differences between these pairings.
- The buyer and generally larger partner this time falls on the European side of the big pond. In the current geopolitical climate, the Chinese regulators that shot down the Qualcomm/NXP merger might be less interested in blocking a deal that appears to favor Europe more than America.
- The scale of this deal is smaller. Infineon and Cypress add up to a total market value of $26 billion at their current prices, nursing a combined $11 billion in annual revenue. That's nothing next to the combined market cap of $116 billion and $30 billion of revenue run rates you see in Qualcomm plus NXP these days. Hence, this smaller and less flashy acquisition seems less useful as a political pinata.
I've been wrong before, and goodness knows that international politics can be unpredictable these days. That being said, it looks like this merger should get a cursory regulatory review and a relatively painless closing.
But is that idea worth an 8% return?
That almost-certain payoff must be weighed against the prospects of the broader market. The S&P 500 benchmark has returned 4% over the last 52 weeks, including some wild swings along the way. The index stands 2% below its annual highs and 24% above the 52-week lows. The markets haven't been this unpredictable since the 2008 crash. Some investors might want to park a bit of cash in a relatively safe 8% gainer like Cypress. It's certainly a more promising cash vault than the average savings account yielding a measly 0.1% per year.
You do have to accept a modicum of risk that isn't there for bank-based savings accounts, and the market could always keep up the momentum that boosted S&P returns to 16% since early January. Given those caveats, Cypress looks like a fairly safe way to earn a modest return over the next few months.
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Anders Bylund owns shares of NXP Semiconductors. The Motley Fool owns shares of Qualcomm. The Motley Fool recommends Cypress Semiconductor and NXP Semiconductors. The Motley Fool has a disclosure policy.