Why Is MER Trading Significantly Below the $29 Per Share BAC Offer?

A reader sent me an email, asking me to explain to him why Merrill Lynch (MER) is trading around $19 per share when Bank of America (BAC) offered to buy MER for $29 a share. Is it the short sellers?

Well, maybe, if they're driving down BAC's share price.

The media is floating around the story that BAC offered $29 a share for MER, but this is based on BAC's closing price of $33.74 on Friday. What BAC offered was a share swap. If the deal goes through, MER shareholders will receive 0.8595 BAC shares for each of their MER shares. So, for example, if you own 100 Merrill shares, if the deal goes through you'll get 85.95 Bank of America shares.

This means that MER's share price is now tied to BAC's. It's trading at a sizable discount to its implied deal value (with BAC trading at $27 and change as I'm writing, the implied value of MER is $23 and change a share), but that's because traders aren't certain the deal will go through and there's a possibility that BAC shares will continue falling.

If you think the deal will fall apart and you own MER, consider selling your shares and buying BAC instead. Part of the reason BAC is falling is that shareholders don't like the deal. If the deal falls apart, BAC may rise. If you think the deal will go through and that BAC has bottomed, continue holding your MER shares. In either case you'll be getting BAC shares. The price is still up in the air.

Another way to get into BAC, which I wrote about previously, is to buy its L Series convertible preferred. They currently sport a dividend yield of around 9%.

I personally would stay away from financial stocks right now. Instead, I'll gamble with small sums on puts and calls.

Disclosure: I own Merrill puts. Disclaimer.

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