Michael Kors Holdings Ltd (NYSE: KORS)
Michael Kors Holdings shareholders were treated to another 5% gain on Wednesday, as traders continue to hear and speculate on chatter of a potential takeover of the company. The stock closed higher by $2.58 to finish the day at $50.10 a share.
Remember, my fellow investors, investing on rumor and speculation is a risky proposition, and, unless you have the ability to watch and trade real time, it can be a dangerous endeavor. Personally, I like to trade on some rumor, it adds excitement to a sometimes boring past time.
I’m not typically naive, but when I hear takeover chatter pertaining to mid- and large-cap names, I often find that there is at least a small tidbit, at a minimum, of truth to the banter and rhetoric that is being circulated around the twittersphere. However, being able to successfully trade on a “tidbit” of potential truth will usually not lead to a prosperous portfolio. So, as traders and investors, we need to pay more attention to the reasons why the speculation is mounting, look at some clues, and then form a reasonable opinion to determine if the rumor is something that can be traded upon.
Trade On A Rumor If Value Exists In The Stock
When determining whether or not I want to risk capital and initiate a speculative position based on a buyout rumor, the first item on my checklist is to determine where the stock is currently trading and compare it to the price that is being rumored as the offer. I need to see value.
In the case of KORS, reports have circulated that the company is studying a $10 billion dollar offer. Doing a quick bit of math, we can determine that, after today’s close, a $10 billion dollar cashiers check made payable to KORS shareholders would represent a premium of slightly over 18% to its current share price and place the sale at roughly $59.00 a share. For many current shareholders, that number might represent a take-“under” from its 52-week high of $59.49 per share. For them, not necessarily a deal that would have them popping the champagne cork.
Prior to the most recent twitter-sphere activity, KORS had been trading in a tight range between $46.00 – $47.00 a share during the prior few weeks. As KORS has not released any substantial news since the beginning of October, the recent run up can be attributed, in part, to the speculative traders that believe KORS to be a prime takeout candidate.
In my opinion, KORS is a good company and may very well have earned the most recent 6% gains based solely on the dynamics within the company and their ability to continue to perform relatively well in a retail environment that is definitely becoming a dart thrower’s paradise. KORS is a company that is continually working to reinvent itself, seeking out niches and exploiting retail opportunities that others fail to capitalize upon. With KORS having a forward P/E of only 11X its FY17 EPS, the company has intrinsic opportunity to work its way higher as investors digest and speculate on the mixed data being published about the consumer spending trends for the holiday season.
With KORS trading at only 11X next years guidance, investors are seemingly willing to rotate out of names such as Coach(COH), Ralph Lauren (RL), and Kate Spade (KATE), which sport forward EPS multiples in the high teens and low- to mid-twenties range. Accordingly, as we crunch down the numbers, KORS, on its own, certainly appears to be worthy of its current share price, and tacking on an additional 18% might only put them in line with peer retailers anyway.
So, when I cipher down the numbers to determine whether it is prudent to invest purely on a rumor, I need to feel relatively secure that the stock would be capable of supporting it’s current price if the rumor burned out without any action. With KORS, my opinion is that the stock can easily justify its current value and has a far greater likelihood to work into an even higher share price if the next set of consumer data indicates a strong holiday season, a reason for the tide to rise, raising all the boats with it.
As far as trading KORS on the rumor, I find it to be relatively safe IF you want to be an owner of the stock for the next six months. But, in doing so, you are also betting on a moderate to strong holiday season that can help insulate your investment in KORS, while at the same time allowing you to enjoy some of the exposure to the speculation aspect of the trade.
Whats A Rumor Without Some Evidence?
Like all good rumors, investors need to look beneath the surface of the market to find some indicators that investors are either accumulating shares or are positioning themselves to benefit from higher prices with a specific trading strategy. I like to gauge the options market, and, although the option pit never tells the whole truth regarding a traders intent, it does allow investors to gauge a reliable level of sentiment toward a stock.
KORS saw a couple of large spikes in its option activity beginning back in September, when, as of the 19th, a bullish bet was made with 4800 weekly call options purchased with a strike price of $47.50 a share. The option volume on that day crushed the historical open interest which sat at just 125 contracts prior to that trade being executed. The call buying outnumbered the put buying by a 5 to 1 ratio on the day. The stock traded up through $51.00 that week, which made that specific transaction successful.
Then, on October 13th, a trader purchased 3100 contracts of the weekly call options with a strike price at $45.50 a share and the trader paid about 70 cents, on average, per contract. The stock traded well through the strike price during the entire week, making it a profitable transaction as the stock continued to trend higher.
Again on October 19th, KORS saw another block transaction betting on the bullish trend to continue with over 3000 contracts purchased with a strike price between $47.00 and $48.00 a share. Those transactions too, at least as of today, are profitable.
So, whats my point? A trader made some money in the options trade, what does that have to do with the takeover speculation?
To truly gauge whether the rumor a stock is trading on has some credibility, I glance back several weeks prior to the rumor’s surface to gauge the activity in the stock during that period. Typically, the retail investor is the last to know of any pending transaction, and, when a viewer watches a segment about the rumor on CNBC, you can bet that the professionals have already placed their bets on the likelihood of the deal coming to fruition.
With KORS, the option activity from early September began a trend of speculative and expensive bets, being that the options purchased were of the weekly variety. Forgetting all of the covered call and hedge strategies, I am focusing on the volume, price, and the ultimate price trend of the share price.
In each of the three instances, the share price followed through the strike price and the shares rallied higher through the next week, when investors again bought additional tranches of contracts. When I see a trend like the one at KORS, it leads me to award a bit more credibility that there are actually wheels spinning behind the scenes. Now, a month later, the rumor about KORS finally surfaces to the forefront and at a price considerably higher than today’s closing price, but not the barn burner of a deal that would get current shareholders overly excited.
However, that’s okay, because we already determined that KORS, at these levels is a relatively safe investment in relation to its peers, and the likelihood of KORS outperforming it’s competitors is potentially greater based on its low forward looking P/E ratio.
Thus, if I was looking to invest into the retail sector and I was searching for value coupled with the potential of an extra bump in price, KORS is an attractive play based on my investment style and risk tolerance. However, with that said, until I can figure out the direction of the retail market, I would stay on the sidelines.
Regardless of what analysts tell the street, I have it on good authority that mall-based retail traffic is slow – very slow. It’s for that reason that I would be careful of pulling the trigger on the KORS trade. Although I have made a case for KORS to trade higher, I find the likelihood of a nervous nellie retail sell off to be highly probable. Unless a retailer has strong on-line sales and marketing strategies, the season for brick and mortar retailers may be tough.
I’m Confused, Should I Buy The Rumor On KORS?
Well, here I sit and ponder the 64K dollar question, which, by the way, is still a lot of money to most people. When the millennials made the term billionaire more popular than millionaire, many people seemed to lose focus on the value of a dollar in hand.
But, back to KORS. I like the trend of option buying, and I further like the fact that the share price has been following the lead. The stock bounced nicely once the rumor surfaced but not to a level that investors can’t justify as a reasonable price for the stock as it is. Based on the speculation of a $10 billion dollar price tag, the upside of 18% is attractive and worthy of an investment, ONLY because the stock is already a value buy in my opinion.
If KORS was trading closer to the $57.00 level, I would stay away, as the downside risk in an uncertain retail arena would be excessive as compared to the potential gain.
With 5800 contracts of the January 2017 call options purchased today at a strike price of $60.00, I believe that the market is sending a signal and representing a trading range for the next couple of months.
The stock is expensive for retail investors in a dollar sense, but, if an investor has the ability to buy at least a hundred shares and sell covered call options at the $60.00 level, the investor can participate in both scenarios, investing in a stock that is positioning itself for growth and also putting themselves in a position to be paid the $60.00 anyway, if the speculation becomes reality. And, if the deal does not happen, the shareholder and seller of the covered call made a little extra cash for the holiday season – not a bad deal when being paid to wait.
In either scenario, KORS can be a winning trade, but investors should be cautious, as the market is nervous, and, until we can get a definitive all clear on the consumer front, investors would be wise to tread carefully.
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Disclaimer: This article expresses the views of the author listed as a contributor on the article. CNA Finance does not necessarily share the views expressed herein. The author holds no position and does not plan on opening a position in any stock mentioned unless expressly stated within the article above.