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Alternative Strategies - Cablevision
 

Alternative Strategies - Cablevision

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Actionable trade ideas for stock market investors and traders seeking alpha by overlaying their portfolios with options, other derivatives, ETFs, and disciplined and applied Game Theory for hedge fund ...

Actionable trade ideas for stock market investors and traders seeking alpha by overlaying their portfolios with options, other derivatives, ETFs, and disciplined and applied Game Theory for hedge fund managers and other active fund managers worldwide. Ryan Renicker, CFA

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    Alternative Strategies - Cablevision Alternative Strategies - Cablevision Document Transcript

    • October 13, 2006 Cablevision Option Strategies Risk Arbitrage Research We highlight three option strategies that allow investors to express various investment views on the Evren Ergin proposed MBO for Cablevision. The current offer from the Dolan group is $27 per share. However, 1.212.526.9376 the $26.91 closing price of Cablevision shares on October 12, 2006 suggests that investors expect eergin@lehman.com an improvement in offer terms. Amit Dholakia 1.212.526.9377 adholaki@lehman.com We believe the fair breakeven probability for an improvement in deal terms to $30 is approximately 65%. The current implied probability of an improvement in deal terms, based on last night’s (10/12) closing price, is about 77%. The options strategies we highlight are intended to offer investors a Derivatives Strategy potentially improved risk/reward (relative to a long-only position) that may also be more consistent with Ryan Renicker, CFA 1.212.526.9425 various views on the announcement of a definitive transaction.ryan.renicker@lehman.com Devapriya Mallick Strategy I: Overwrite Long CVC position – Moderately Bullish 1.212.526.5429 dmallik@lehman.com • Write Jan 07 27.5 Calls against long stock for $0.90. • The implied breakeven probability of an improvement in deal terms for an overwrite strategy is about 72%. Strategy II: CVC Risk Reversals – Bearish View • Buy CVC 25 puts and sell CVC 27.5 calls for a bearish risk reversal expiring in Jan. Net premium from the transaction is $0.50. • For this strategy, the implied breakeven probability of an improvement in deal terms is about 16%. However, this strategy is intended to express a bearish investment view that would benefit if a definitive agreement is not reached, and would therefore be associated with a low implied probability of an improvement in deal terms. • If we consider the risk-reversal strategy in addition to a long stock position, the implied breakeven probability is roughly 71%, which is in line with the other strategies we highlight. Strategy III: CVC 1x2 Call Spreads – More Bullish • Buy CVC Jan07 25-27.5 1x2 Call Spreads for $1.05 to add to long position. • The long stock with a 1x2 call spread has an implied breakeven probability of an improvement in deal terms of about 75%.Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict ofinterest that could affect the objectivity of this report.Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them,where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2LEHMAN to request a copy of this research.Investors should consider this report as only a single factor in making their investment decision.PLEASE SEE ANALYST(S) CERTIFICATION AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 6.
    • Equity Derivatives Strategy | Cablevision Option Strategies CVC Proposed MBO – Option Strategies We highlight three option strategies that allow investors to express various investment views on the proposed MBO for Cablevision. These strategies may present investors with a more favorable risk/reward for a particular investment view relative to a long equity position. The current offer from the Dolan group is $27 per share. However, the $26.91 closing price of Cablevision shares on October 12, 2006 suggests that investors expect an improvement in offer terms. In this report, we refer to information and assumptions initially detailed in an earlier Lehman Brothers Risk Arbitrage Research report1. We present assumptions from that report that are relevant to the highlighted options strategies. We also note that these option strategies are generally intended to express a view over the time frame until negotiations between the Dolans and the Cablevision special committee reach a resolution (i.e. either a definitive agreement is reached or negotiations are terminated). Key Assumptions (please see our prior Risk Arbitrage report for complete details) Timing: based on limited precedents, negotiations in proposed MBOs generally take about three months to reach a resolution. Increase in Offer Terms: The current offer from the Dolan group is $27 per share. A $30 final offer price appears achievable. However, there are reasonable risks (both to the upside and downside) in estimating a final offer value. Downside: We are assuming a downside price of $23.50 for Cablevision shares in the event that negotiations are terminated without a definitive agreement. Fair Spread in a Definitive Agreement: We estimate a fair annualized spread in a definitive transaction for Cablevision to be roughly 14-15%. Breakeven Probabilities • According to the assessment of our Risk Arbitrage Research team, the fair breakeven probability for an improvement in deal terms is approximately 65% based on the assumptions above. • The current implied probability of an improvement in deal terms, based on October 12, 2006 closing prices and the assumptions above, is about 77.1%. • We highlight the current implied breakeven probabilities associated with an improvement in deal terms, based on October 12, 2006 closing prices, for each of the three option strategies we consider. 1 Please refer to Proposed MBO of Cablevision, October 10, 2006 for further details. October 13, 2006 2
    • Equity Derivatives Strategy | Cablevision Option Strategies Strategy I: Overwrite Long CVC position – Moderately Bullish • Write Jan 07 27.5 Calls against long stock for $0.90. • Breakeven if stock closes at or below $28.40 as of January 19. • Arb investors can implement this as a buy-write to reduce the cost of entry into the stock, especially if they want to own CVC shares following a potential definitive agreement. • Short-dated implied vols have picked up since the vol crush immediately following deal announcement. Selling upside calls helps monetize the higher volatility. • The strategy benefits if a definitive agreement is reached before January. Based on limited precedents, proposed MBOs take about three months to reach a resolution. • A modest bump in deal terms could also be a positive for the position. • One risk to overwriters would be the upside they would have to forego in the event of a significant improvement in deal terms. • In case a definitive agreement is not reached and CVC shares trade lower, buy-write investors would be protected on the downside only to the extent of the premium received from the written call ($0.90). • The implied breakeven probability of an improvement in deal terms for an overwrite strategy is about 72%. Figure 1: Expiration Payoff for CVC Overwrite Strategy 6 Expiration Payoff from Call Overwrite Underperform long- 4 Initial premium from only beyond $28.40 call = $0.90 2 0 -2 -4 -6 23 24 25 26 27 28 29 30 31 32 33 CVC Price at Jan Expiration Source: Lehman Brothers, Bloomberg October 13, 2006 3
    • Equity Derivatives Strategy | Cablevision Option Strategies Strategy II: CVC Risk Reversals – Bearish View • Buy CVC 25 puts and sell CVC 27.5 calls for a bearish risk reversal expiring in Jan. Net premium from the transaction is $0.50. • The long puts implement a more bearish view than the overwrite position alone. In the event that no definitive agreement is reached, CVC may trade down to roughly $23-24 (pre- announcement price was $23.53). A bearish risk reversal would benefit from such a pull- back. • Based on limited precedents, approximately 40% of proposed MBOs do not result in a definitive agreement. • The breakeven on the upside is $28, beyond which any improvement in deal terms exposes the investor to unlimited downside risk. However, we would expect the stock price at expiry to reflect a fair annualized spread to the final offer price. • For this strategy, the implied breakeven probability of an improvement in deal terms is about 16%. However, this strategy is intended to express a bearish investment view that would benefit if a definitive agreement is not reached, and would therefore be associated with a low implied probability of an improvement in deal terms. • If we consider the risk-reversal strategy in addition to a long stock position, the implied breakeven probability is roughly 71%, which is in line with the other strategies we highlight. Figure 2: Expiration Payoff for CVC January Risk Reversals 3 Expiration Payoff from Risk Reversa Dow nside protection 2 below $25 Short upside beyond $28 1 0 -1 -2 -3 23 24 25 26 27 28 29 30 CVC Price at Jan Expiration Source: Lehman Brothers, Bloomberg October 13, 2006 4
    • Equity Derivatives Strategy | Cablevision Option Strategies Strategy III: CVC 1x2 Call Spreads – More Bullish • Buy CVC Jan07 25-27.5 1x2 Call Spreads for $1.05 to add to long position. • Allows leveraged upside participation to $27.50. Breakeven for the strategy (relative to a long-only position) is $28.95, beyond which the trade begins to under-perform a long-only position. • This is a more bullish strategy than the overwrite and allows participation up to a higher range of final offer prices (if a definitive agreement is reached). • The long call position is currently in the money and the strategy would remain profitable even if no definitive agreement is reached by the January expiration and stock price volatility remains limited. • This is a means of selling volatility in the January line, which could fall sharply from the current 17% level if a definitive agreement is reached. • One risk to the strategy is that if no definitive agreement is reached, there is no protection to the long stock position on the downside and the investor loses the net premium of $1.05. • Earnings announcement in November could be another catalyst for stock price volatility, though CVC does not tend to react strongly to earnings (the stock has moved about 2.5% on average following the last eight earnings releases). • The long stock with a 1x2 call spread has an implied breakeven probability of an improvement in deal terms of about 75%. Figure 3: Expiration Payoff for Jan 1x2 Call Spreads With Long Stock 6 Expiration Payoff for 1x2 Call Spreads Leveraged upside 4 betw een 25-27.5 2 0 -2 -4 Exposure to dow nside and $1.05 premium loss -6 23 24 25 26 27 28 29 30 31 32 33 CVC Price at Jan Expiration Source: Lehman Brothers, Bloomberg October 13, 2006 5
    • Equity Derivatives Strategy | Cablevision Option StrategiesAnalyst Certification:We, Evren Ergin and Ryan Renicker, hereby certify (1) that the views expressed in this research email accurately reflect our personal views about any or all of thesubject securities or issuers referred to in this email and (2) no part of our compensation was, is or will be directly or indirectly related to the specificrecommendations or views expressed in this email.To the extent that any of the conclusions are based on a quantitative model, Lehman Brothers hereby certifies (1) that the views expressed in this research emailaccurately reflect the firms quantitative research model (2) no part of the firms compensation was, is or will be directly or indirectly related to the specificrecommendations or views expressed in this research report.Important DisclosuresLehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have aconflict of interest that could affect the objectivity of this email communication.Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost tothem, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2-LEHMAN to request a copy ofthis research.Investors should consider this communication as only a single factor in making their investment decision.The analysts responsible for preparing this report have received compensation based upon various factors including the Firm’s total revenues, a portion of which isgenerated by investment banking activities.Stock price and ratings history charts along with other important disclosures are available on our disclosure website at www.lehman.com/disclosuresAnd may also be obtained by sending a written request to: LEHMAN BROTHERS CONTROL ROOM , 745 SEVENTH AVENUE, 19TH FLOOR NEW YORK, NY10019Mentioned StocksCablevision Systems (CVC - USD26.86) 2-Equal weight / Neutral A/D/J/LRisks Which May Impede the Achievement of the Price Target: The major risks to our S/T growth outlook is CVCs ability to roll out digital services in line withexpectations. DBS remains key competitive threat in the near term, while Verizons fiber rollout is a significant long-term threat. Inconsistent strategy and non-coreinvestments have historically been a negative for the stock.Disclosure Legend:A: Lehman Brothers Inc. and /or an affiliate managed or co-managed within the past 12 months a 144A and/or public offering of securities for this company.D: Lehman Brothers Inc. or an affiliate has received compensation for investment banking services from the subject company within the past 12 months.E: Lehman Brothers Inc. or an affiliate expects to receive or intends to seek compensation for investment banking services from the subject company within the nextthree months.F: Lehman Brothers Inc. and/or its affiliates beneficially own(s) 1% or more of any class of common equity securities of the subject company as of the end of the lastmonth.J: Lehman Brothers Inc. or an affiliate trade(s) regularly in the shares of the subject company.K: Lehman Brothers Inc. has received non-investment banking related compensation from the subject company within the last 12 months.L: The subject company is or during the past 12 months has been an investment banking client of Lehman Brothers Inc. and/or an affiliate.M: The subject company is or during the last 12 months has been a non-investment banking client (securities related services) of Lehman Brothers Inc.Options are not suitable for all investors and the risks of option trading should be weighed against the potential rewards.Supporting documents that form the basis of the recommendations are available on request. Please note that the trade ideas withinthis report in no way relate to the fundamental ratings applied to European stocks by Lehman Brothers Equity Research.Guide to Lehman Brothers Equity Research Rating SystemOur coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3-Underweight (see definitions below) relative to othercompanies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (“the sector coverage universe”). To see a list of companies thatcomprise a particular sector coverage universe, please go to www.lehman.com/disclosures. October 13, 2006 6
    • Equity Derivatives Strategy | Cablevision Option StrategiesIn addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below).A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research report including thedefinitions of all ratings and not infer its contents from ratings alone.Stock Rating1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.RS-Rating Suspended - The rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstancesincluding when Lehman Brothers is acting in an advisory capacity on a merger or strategic transaction involving the company.Sector View1-Positive - sector coverage universe fundamentals are improving.2-Neutral - sector coverage universe fundamentals are steady, neither improving nor deteriorating.3-Negative - sector coverage universe fundamentals are deteriorating.Distribution of Ratings:Lehman Brothers Equity Research has 1945 companies under coverage.44% have been assigned a 1-Overweight rating which, for purposes of mandatory disclosures, is classified as a Buy rating, 33% of companies with this rating are investmentbanking clients of the Firm.40% have been assigned a 2-Equal weight rating which, for purposes of mandatory disclosures, is classified as a Hold rating, 6% of companies with this rating areinvestment banking clients of the Firm.16% have been assigned a 3-Underweight rating which, for purposes of mandatory disclosures, is classified as a Sell rating, 65% of companies with this rating areinvestment banking clients of the Firm.This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates (“Lehman Brothers”) and has been approved byLehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in the European EconomicArea. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. This material is distributed in Australiaby Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch. (“LBIS”). Where this material is distributed by LBIS, pleasenote that it is intended for general circulation only and the recommendations contained herein does not take into account the specific investment objectives, financialsituation or particular needs of any particular person. An investor should consult his Lehman Brothers’ representative regarding the suitability of the product and takeinto account his specific investment objectives, financial situation or particular needs before he makes a commitment to purchase the investment product. This materialis distributed in Korea by Lehman Brothers International (Europe) Seoul Branch. This document is for information purposes only and it should not be regarded as anoffer to sell or as a solicitation of an offer to buy the securities or other instruments mentioned in it. No part of this document may be reproduced in any mannerwithout the written permission of Lehman Brothers. With the exception of disclosures relating to Lehman Brothers, this research report is based on current publicinformation that Lehman Brothers considers reliable, but we make no representation that it is accurate or complete, and it should not be relied on as such. In the caseof any disclosure to the effect that Lehman Brothers Inc. or its affiliates beneficially own 1% or more of any class of common equity securities of the subject company,the computation of beneficial ownership of securities is based upon the methodology used to compute ownership under Section 13(d) of the United States SecuritiesExchange Act of 1934. In the case of any disclosure to the effect that Lehman Brothers Inc. and/or its affiliates hold a short position of at least 1% of the outstanding October 13, 2006 7
    • Equity Derivatives Strategy | Cablevision Option Strategiesshare capital of a particular company, such disclosure relates solely to the ordinary share capital of the company. Accordingly, while such calculation representsLehman Brothers’ holdings net of any long position in the ordinary share capital of the company, such calculation excludes any rights or obligations that LehmanBrothers may otherwise have, or which may accrue in the future, with respect to such ordinary share capital. Similarly such calculation does not include any sharesheld or owned by Lehman Brothers where such shares are held under a wider agreement or arrangement (be it with a client or a counterparty) concerning the sharesof such company (e.g. prime broking and/or stock lending activity). Any such disclosure represents the position of Lehman Brothers as of the last business day of thecalendar month preceding the date of this report.This material is provided with the understanding that Lehman Brothers is not acting in a fiduciary capacity. Opinions expressed herein reflect the opinion of LehmanBrothers and are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries, and they may notbe suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothers representative. The value of and theincome produced by products may fluctuate, so that an investor may get back less than he invested. Value and income may be adversely affected by exchange rates,interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product is income producing, part of the capital invested may beused to pay that income. © 2006 Lehman Brothers. All rights reserved. Additional information is available on request. Please contact a Lehman Brothers entity in yourhome jurisdiction.Lehman Brothers policy for managing conflicts of interest in connection with investment research is available at www.lehman.com/researchconflictspolicy. Ratings,earnings per share forecasts and price targets contained in the Firms equity research reports covering U.S. companies are available atwww.lehman.com/disclosures.Complete disclosure information on companies covered by Lehman Brothers Equity Research is available at www.lehman.com/disclosures. October 13, 2006 8