The $17 billion merger between Eldorado Resorts (NASDAQ: ERI) and Caesars (NASDAQ: CZR) will produce the world’s largest casino company. Many investors were not giving these companies much thought as the merger still needed the regulatory green lights. However, Eldorado Resorts received the ‘final yes’ from New Jersey regulators on Friday. The merger is now set for next week. The confirmation is causing the Eldorado and Caesar bulls to multiply. However, sometimes mergers can be confusing. Thus, today we will provide our readers with a breakdown of the merger, the effect on current stockholders, and possible investment strategies to consider.
Table of contents 1. What are the elements of the merger? 2. How will option holders be impacted? 3. Possible investment strategies to consider.
Overview of the Eldorado-Caesar merger.
The merger will see Eldorado control over 50% of the combined casino properties. Despite Eldorado having control, they decided to keep the iconic name of Caesar International Incorporated. According to both companies, “Eldorado will acquire all of Caesar’s shares for $12.75 each”. Of the $12.75, $8.40 will be distributed to previous stockowners as cash. The remaining $4.35 will be converted into shares of the newly merged casino giant.
What does the merger mean for option holders?
Understanding how shareholders are impacted in a merger is usually fairly simple. Existing shareholders can receive a cash payout, shares in the newly merged company, or a cash buyout plus shares in the new company. However, option holders do not own the stock. Thus figuring out how options, in particular call holders, are affected can be confusing.
Call options allow investors to purchase the stock at a given strike price in the future. Usually, most investors will not exercise until their call option is in the money, meaning the stock price is higher than the strike price. In theory, stock prices can rise forever.
However, a merger places a ceiling on the stock price. In the case of Caesar, Eldorado Resorts set the price ceiling at $12.75. Now we must compare the price ceiling of $12.75 to the call options strike price. If your strike price is higher than $12.75, so $13 for example, your options will lose a significant amount of value and may end up worthless. Because the stock will never reach that strike price. Also, the further your strike price is away from the buyout price the more decay you will experience. Hence, if you bought Caesar calls with a $20+ strike price, the value should significantly decrease. Thus, purchasing overly ambitious call options near a merger can be extremely risky, as seen with Caesar.
Conversely, if your strike price is below the $12.75, then your call option should see a spike in value. (opinion not advice) Considering Caesar’s share price is $12.42, options contracts with a strike price of $12.42 or less should see an increase in value. YIG would like to point out that the mergers price ceiling often causes shareholders to grab profits early. Ultimately, triggering a potential rise in put options.
Breakdown of possible investment strategies.
Before I begin, I am obliged to remind our viewers that this is not financial advice but rather my commentary from my extensive research.
Investing in Eldorado Call options
To say the Eldorado-Caesar merger is the biggest headline in the 2020 gambling industry would be an understatement. (opinion not advice) The merger should attract a lot more bulls to the newborn casino giant. These bulls should include existing Caesar shareholders and new investors. The anticipated buying could trigger an explosive run in the first few weeks. The expected rise gives weight to an investment in Eldorado call options. Initially, investing in out of the money calls might seem attractive. Because they are cheaper, and the expected surge could result in a nice gain.
However, YIG would like to point out that mitigating your risk in times of market volatility is crucial. Thus, investing in Eldorado call options in the money or slightly out of the money seems like the smartest investment. Because if Eldorado does not experience volcanic activity, then could still walk away with a gain, as opposed to a possible worthless call option. (opinion not advice)
Initially, you might think casinos and gambling would endure massive blows from the virus. However, that is not the case. The coronavirus impacted low-limit table games, the pokies, and other low margin aspects of the casino life. At face value, that might seem distressing, but these areas, according to Eldorado’s CEO Thomas Reeg, “provide the lowest profit margins”. Ultimately, allowing “cash flow to continue to be strong” – Thomas Reeg. Also, Eldorado’s partnership with William Hill should allow them to tap into the growing sportsbetting sector. Overall, Eldorado is poised for long-term growth based on their newly acquired Caesar portfolio and sports betting growth prospects. Thus, a long-term investment in Eldorado Resorts seems like a wise investment. (Opinion not advice)
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The information above should not be taken as financial advice. Youth Investment Group has no liability for personal financial interests or investment decisions. You should make your own investment decisions based upon your own research and what you believe is best for you.
Written by Patrick McLoughlin, Senior Manager of YIG.