Bloomberg News

RadioShack Options Signaling Deal as Short Sales Climb: Real M&A

February 13, 2012

Feb. 10 (Bloomberg) -- As short sellers push bearish wagers against RadioShack Corp. to a four-year high, options traders are increasing bets that the cheapest U.S. specialty retailer will become a takeover target.

Almost 24 percent of RadioShack’s shares are currently shorted, the most since January 2008 and four times the average of the Standard & Poor’s Midcap 400 Index, according to New York-based research firm Data Explorers. After posting the second-steepest two-year decline in the S&P Midcap 400, Fort Worth, Texas-based RadioShack trades at 5.8 times profit, the lowest of any specialty retailer in America worth more than $500 million, data compiled by Bloomberg show.

While RadioShack’s earnings are shrinking because of stagnant consumer spending, rising dependence on mobile-phone sales and lower-than-projected revenue from Sprint Nextel Corp., it’s also one of only two companies in the industry valued at a discount to net assets. The cost of calls to buy shares priced 10 percent above RadioShack’s stock reached a five-year high this week versus puts to sell on comparable one-month contracts, signaling some traders may now be speculating the company is cheap enough to attract a takeover offer, said Frederic Ruffy, a senior options strategist at WhatsTrading.com.

“They are in a tough situation,” Todd Lowenstein, who helps oversee about $17 billion for Highmark Capital Management Inc. in Los Angeles, said in a phone interview. “You have people who, in the current scheme, are willing to bet negatively, but ultimately there’s a price for somebody to come in and say it’s attractive. Everything has a price. There will be vultures that will circle and will be willing to step in at a price. This thing is cheap.”

Declining Profit

Eric Bruner, a spokesman for RadioShack, said the company doesn’t comment on market speculation.

RadioShack rose 1.3 percent to $7.57 at 10:49 a.m. in New York.

RadioShack, which opened its first namesake store in 1921, has almost 7,300 locations in the U.S. and Mexico, including mobile centers in Target Corp. stores. It sells everything from GPS navigation systems to metal detectors and mobile phones. In September, company-operated stores also began carrying Verizon Wireless products and services.

Last month RadioShack suspended share repurchases and disclosed preliminary fourth-quarter profit that was a third of the amount analysts estimated because of holiday promotions amid “ongoing pressure” on consumer spending and “underperformance” in the Sprint wireless business.

Short Sellers

The Jan. 30 announcement sent the stock tumbling 30 percent the next day, the biggest decline in at least 30 years, to $7.18 a share, the lowest since March 2009. RadioShack has now lost 61 percent in the last two years, reducing the company’s market value to $746 million as of yesterday, while the S&P Midcap 400 gained 39 percent, data compiled by Bloomberg show.

Almost 24 million of the 99.8 million outstanding shares of RadioShack were being shorted as of Feb. 7, according to Data Explorers. In a short sale, traders sell borrowed stock on the assumption the price will decline and enable them to profit by buying the shares back at a lower price.

At 24 percent, the proportion of bearish bets against RadioShack is now higher than 98 percent of companies in the S&P Midcap 400, the data show. Companies in the index have average short interest of 5.2 percent. A year ago, less than 4 percent of RadioShack’s shares were being sold short.

Debt Market

The debt market is also signaling a decline as credit investors pay the most ever to protect against a default. Credit swaps tied to RadioShack rose to a record $971,105 to protect $10 million of debt on Jan. 31, the day after it reported preliminary earnings, according to data provider CMA. Default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

After losing $1.7 billion in market value in the last two years, RadioShack has fallen to 5.8 times earnings, the lowest price-earnings ratio of any U.S. specialty retailer worth more than $500 million, data compiled by Bloomberg show. The industry average is 18.3 times.

The January stock decline sparked by the disappointing earnings report pushed RadioShack down to 0.9 times book value, the lowest since at least 1990, according to data compiled by Bloomberg. The shares still trade at a 7 percent discount to net assets, cheaper than every company in the industry group except for OfficeMax Inc., the data show.

Best Buy, Sears

“Any time a company is trading at below book value or below tangible book value, it’s trading below its liquidation value,” said Highmark Capital’s Lowenstein. “Suitors, whether strategic or financial, would tend to be very interested in these kinds of cases.”

RadioShack, which failed to sell itself in 2010, may now be cheap enough to attract buyers, according to Lowenstein. At least three private equity firms dropped out of the bidding in 2010, Bloomberg News reported at the time, citing people familiar with the discussions.

The company operated more than 6,000 retail locations as of Sept. 30, according to a regulatory filing. Almost all of RadioShack’s locations are leased rather than owned.

While RadioShack was a compelling takeover target in the past for Best Buy Co., Sears Holdings Corp. or a private equity firm, it’s now less likely to find a buyer as RadioShack and rival retailers combat increasing sales on the Internet, said Sachin Shah, a Jersey City, New Jersey-based special situations and merger arbitrage strategist at Tullett Prebon Plc.

‘Dangerous Situation’

“It’s kind of a dangerous situation in the context that the business model may be eroding,” Shah said in a phone interview. “It’s not a cyclical situation, it is systemic. Is RadioShack cheap? Yes, it is if you have a buyer, and it’s not clear to me that there is a buyer out there.”

Options traders are growing increasingly bullish. The cost of calls to buy the stock versus puts to sell jumped 29 percent from its Jan. 27 low to a five-year high on Feb. 8. That was the biggest gain in such a number of days since March 2010, according to data on 30-day options compiled by Bloomberg. As of Feb. 8, calls that pay off if RadioShack rises 10 percent cost 1.1 times more than comparable puts on one-month contracts, the data show. The ratio was 1.06 yesterday, the data show.

Some traders may be using RadioShack call options to protect shares they sold short in case the stock rises and creates a so-called short squeeze, said Alec Levine, an equity derivatives strategist at Newedge Group SA in New York. In a short squeeze, traders with short positions are forced to buy the securities to cover their positions and limit losses while the surge of buying results in even higher prices.

“It’s possible that this is showing just straight speculative buying on the potential for a takeover,” Ruffy, who analyzes the options market for WhatsTrading.com in New York, said in a phone interview. “There’s limited downside at these levels and potential for big upside.”

--With assistance from Cecile Vannucci, Nick Baker and Sapna Maheshwari in New York. Editors: Sarah Rabil, Daniel Hauck.

To contact the reporters on this story: Tara Lachapelle in New York at tlachapelle@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net.


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