Don't Take a Flier on Orbitz's Stock!

The Federal Reserve gave an upbeat assessment of the economy in yesterday's monetary policy statement. While policymakers are non-committal on the exact timing of the first interest rate hike, yesterday's release suggests they are still on track for a 2015 lift-off, contingent on additional data confirming the economy and labor market are improving. 

We already have one such piece of confirming data: today's second-quarter GDP print from the Commerce Department. Although it came in below the 2.9% consensus estimate, 2.3% quarter-over-quarter (annualized) growth is a decent result, particularly as the first-quarter growth rate was revised higher, turning a 0.2% contraction into a 0.6% gain. 

Traders appear nonplussed, however, with the Dow Jones Industrial Average (^DJI 0.30%) and the broader S&P 500 (^GSPC 1.11%) down just 0.07% and 0.11%, respectively, at 12 p.m. EDT. The Nasdaq Composite was up 0.19%. 

Don't take a flier on Orbitz's stock
Yesterday, shares of online travel agency OrbitzWorldwide (NYSE: OWW) closed at $10.82 -- a 10% discount to the $12 per share acquisition offer Expedia Inc (EXPE 0.41%) announced on Feb. 12. The magnitude of that discount suggests that the market is genuinely skeptical the deal will be completed. 

Or, as UBS analyst Eric Sheridan put it to Yahoo! Finance this morning: "The likelihood that deal gets regulatory approval in DC is going down. If that deal were to not go through, the stock would drop quite a bit." 

Earlier this month, Mr. Sheridan downgraded Orbitz from neutral to sell and lowered his price target from $12 to $10 (note that this in the same neighborhood as the $9.87 closing price on the day prior to the acquisition being announced). In his note, he wrote: 

Based on a combination of recent press reports & our own industry conversations, we believe there are increasing antitrust concerns surrounding the proposed EXPE-OWW transaction. Specifically, our conversations suggest increasing levels of concern being voiced by travel suppliers to regulators regarding an already largely consolidated US OTA [Online Travel Agencies] market. Further, we note a growing list of transactions recently derailed by regulatory opposition (Comcast & Time Warner, Sysco & US Foods, Electrolux & GE Home Appliance).

However, traders appear to believe the likelihood the deal will go through is up this morning, with Orbitz's shares gaining 4.53% at 12 p.m. EDT, to $11.31. They may well be reacting to an article in the New York Post citing an unnamed source "close to the situation," according to whom the deal would be approved by the end of August. 

The stock price since the deal was announced has traded in a range of $10.76 to $11.79, reflecting merger arbitrageurs' evolving assessment of the deal's likelihood. According to Bloomberg, the volume-weighted average price of Orbitz's stock over that period is $11.57, or a 3.6% discount to the deal price. Even that average discount is relatively substantial in a world in which the 1-year Treasury bill yields less than a 10th of that, at 0.34% this morning. Bear in mind that arbitrageurs typically employ leverage to boost their returns. 

I'd strongly recommend individual investors refrain from betting on this deal by buying Orbitz shares. If we assume a downside price around $10 if the deal fails, and an upside fixed at $12, the current risk/reward proposition looks very unattractive. An individual investor should never bear equity risk with the hope of capturing a single-digit return!