Wall Street is putting roughly 85% odds that Paramount Skydance's $110 billion deal for Warner Bros. Discovery will get completed despite the antitrust lawsuit filed in July by a group of state attorneys general led by California's Rob Bonta.
Investors are betting that Paramount, led by CEO David Ellison, will work out a deal with Bonta.
The Bonta-led suit, which argues that the combined company would have too much power over the movie and cable TV distribution, is due to go to trial in March, but investors figure a deal will be reached before then. The state suit is the last remaining obstacle to the deal, which has been approved by more 60 global regulatory agencies.
The odds of the deal getting done have risen from just over 50% in the past month, when investors were more pessimistic that the Bonta-led suit could kill the media and entertainment combination.
The implied odds can be inferred from the stock price of Warner Bros., which has risen 13% to $28.53 since a low reached in late July. Warner Bros. stock, which fell 0.8% Monday, now trades for $2.47 a share below the value of Paramount's cash offer of $31 a share.
Paramount shares also have rallied on hopes the deal will close. Its shares are up 35% to $10.88 from their July 31 low of $7.62, but still trade for a little over half the 52-week high of almost $21 set nearly a year ago.
Traders figure the implied odds of deal completion by comparing the upside in Warner Bros. stock to the estimated downside if the deal gets blocked and doesn't close.
Some estimate that Warner Bros. stock could trade down to between $15 and $16 a share if the deal dies. That's a big decline, reflecting the big run-up in Warner Bros. stock before Paramount won a bidding war with Netflix in February.
There is still a reasonable amount of upside of about 8% in the Warner Bros. stock relative to the deal price of $31.
Paramount is aiming to get the deal done by the end of September, when a 25-cent quarterly "ticking" fee begins that will add to the cost of the transaction. If a deal gets completed within a month, Paramount would avoid that fee and investors would get a nice return.
How are the deal odds figured? If there is upside of about $2.50 a share and downside of around $13 a share, the implied odds are around 85%. The math involves taking the estimated downside and dividing that by the upside plus downside. That percentage is the odds of the deal. In this case it would be $13 divided by $15.50.
Roy Behren, the co-manager of the $2.5 billion Merger Fund, which invests in takeover situations, thinks the odds of the deal getting done are about 90%. He views the Bonta-led lawsuit as weak on its merits and believes that Paramount will be able to work out an agreement with the states. The Merger Fund has about $200 million invested in the Warner Bros. stock, making it one of its largest holdings.
Behren says there should be a way for Bonta to save face and get some of what he wants without impairing the strategic thrust of the transaction. There is also pressure on Ellison to settle since the ticking fee would cost about $650 million per quarter and a trial, while winnable, could delay the deal until the middle of next year and potentially kill it.
Ellison was upbeat on Paramount's second-quarter conference call in early August: "we remain highly confident that this transaction will close, and we're preparing for basically a successful combination once it does," he said.
A lot of money is betting that Ellison is right.
A who's who of investment managers associated with takeover arbitrage and special situations held the stock at the end of June, according to filings tracked by Bloomberg. These include Millennium Management, Pentwater Capital Management, Citadel Advisors, DE Shaw and Third Point.
Warner Bros. probably is one of the largest deals now held in the takeover arbitrage community.
The big money is betting on the deal getting done and investors with a stomach for risk can play alongside them with Warner Bros. stock.