E Calculated Risk And Measured Return With EMC

If there is 27% of annual upside potential why would EMC stock trade below $30?

There are number of reasons stocks trade below their post-merger value prior to an acquisition. Investors may be concerned that Dell will not get Federal Trade Commission approval for the merger due to competitive business reasons. VMware's price potentially could go down in the next eight months from the current $60 to below $20. Investors may not be able to hedge their investment positions by  appropriately shorting VMware. Cost of the investor’s capital could be more than 18%.

Despite all these risk factors we believe the chances of EMC/DELL merger are high.  In the worst case scenario, if the merger falls through the risk of owning EMC shares is not that bad. EMC owns 80% of VMware. VMware is trading 15 times its trailing free cash flow making for a relatively inexpensive stock.  EMC is trading at 12 times its free cash and yielding 1.8%.  Given all these risk factors, that return on EMC for the next eight to twelve months is very appealing.

 

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Disclosure: Long on EMC. Owned in personal and client portfolios.

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