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Saturday, December 19, 2009

Wacky Trading Offers Merger Arbitrage Opportunity in Youbet.com

To put it plainly, stock moves for numerous companies appeared a bit wacky today -- some up, others down. An AP article noted the following:
  • The day began with a frenzy of buying and selling as several types of options contracts expired. Volatility was also high as several stocks were added to and dropped from the Standard & Poor's 500 index, a widely used benchmark and the basis for many indexed mutual funds. Trading on the New York Stock Exchange topped 3 billion shares for the first time. The prior record, just short of 3 billion shares, came in September last year.
One obvious example of funny trading -- Youbet.com (UBET, $2.62) experienced a sudden, late day decline on heavy volume:

We noted the other week that a rising share price for Churchill Downs (CHDN, up $0.08 Friday to $35.60) implies a higher value for Youbet.com. Based on CHDN's closing share price, if the acquisition closed on Monday, Youbet.com shareholders would receive an estimated $3.10 in value ($0.97 cash plus CHDN stock), or +18% from $2.62. While a slight discount from implied value is normal prior to the close of any transaction (given risk of falling apart), we think the acquisition will proceed.

Accordingly, the wide discount created by Friday's late day decline appears irrational. Assuming the discount persists early next week, it provides current UBET buyers with meaningful near-term upside potential.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long UBET.

© 2009 Jeffrey Walkenhorst
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