Friday, May 26, 2006

ACS- Affiliated Computer Services- Sold the July $50 put

ACS has been extremely volatile over the past few years, as evidenced by the attached chart. From looking at the volatility, one might never guess that their underlying business activities are fairly benign, such as processing student-loan payments and setting up toll-booth collections for various states.

After 5 years of back-and-forth activity in the stock price, the company decided to implement a dutch-auction buyback for half of the company (in response to an unsolicited buyout offer from private investors). But like a tree that falls in the forest, what happens when you do a dutch auction and nobody is there to tender their shares at $63? I can answer that question.... your stock price will fall to $49. The company now has a $5Bln credit facility and a $7Bln enterprise value, which would allow them to buy-back up to 2/3rds of their stock if they really wanted. Conversely, if their stock price were to fall much more, me-thinks that whatever LBO buyer was interested at $55+++ would be back in the game buying up shares at sub-$50 stock prices.

So, between a potential buyout above $50 and a potential new share buyback, there seems to be downside protection below $50. Additionally, the long-range value of the company is about $50-$55/share from my estimates, so I feel comfortable writing (selling) a $50 put expiring in July. I collect $200 if the stock finishes at $50 or higher and my adjusted purchase price if it falls is $48. Given that the odds of a shareholder buyback increase significantly the more the stock price falls, a price decline might actually be a positive event. While I am bullish on the company, their name is involved in an options-backdating scandal and several other negative headlines events that should not be overly material to them (i.e- less than $100MM aggregate for all items).

Recommendation- Sold the July $50 puts (conversely, you could buy the stock at $49 and sell the July $50 calls). This basically provides you an income while negating upside above $50. In actuality, it may be a better risk/reward trade to just buy the stock (in the event it gets bought out at $60/share), but I like to make things complicated sometimes. My last idea like this (WLS) worked out way better than I could have imagined, rising from a price of $73 to $128 within the past two months.