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Latest Drug Company Deal Not Drawing Believers

Disappointment frosted over Wall Street with news of the proposed Monsanto (MTC)- Pharmacia & Upjohn (PNU) merger.

But that didn't stop investors from trying to make money off the news.

Volatility Index
Today % Change
24.18 +1.14
Source: ILX

"It's a combination of two weak companies," says Steven Eick with New York arbitrage shop Avery Partners. Rumblings about Monsanto shopping itself around had spread across the Street since the November news of the ever-complicated American Home Products (AHP)- Warner-Lambert (WLA) merger that has degenerated into a run at Warner-Lambert by Pfizer (PFE).

But sell-side research had hinted the best price for Monsanto would probably come if it axed itself into pieces, possibly fetching somewhere in the mid-50s, Eick said.

So news Monday of the proposed tie-up with Pharmacia "was not unexpected. In fact, it was sort of dreaded," he added.

Ewww gross! Wall Street screwed up its face at the deal as if the two ugly kids in the class had decided to go to the prom together. Monsanto stock sank 5 3/4 to 36; Pharmacia fell 4 1/16 to 46 7/16.

Put/Call Ratio
Today (Noon) Previous Close
0.35 0.34
Source: ILX
"It's tempting to get involved" in playing the Monsanto-Pharmacia deal using stock or options strategies, said Larry Garshofsky, a hedge fund manager and arbitrager in Los Angeles. "Whenever you see a stock down 5 in a 'merger of equals' situation, it can draw some attention -- maybe a third-party bidder." He has no position in either company.

"Generally, the market doesn't like mergers of equals because people are looking for premiums. You own a stock and hope for a takeout at a premium. Monsanto was a pretty pregnant situation" after the November American Home Products-Warner Lambert marriage proposal drew in Pfizer as a rival bidder . That resurrected Monsanto as a takeover target since it had a deal with American Home fall through earlier and investors saw the chance of it being rekindled.

"But this deal is a disappointment," he sighed. Moreover, the arb community, which makes its money by betting on the likelihood of mergers and takeover deals going through, has been burned recently by the canceled Alza (ALZA)- Abbott Laboratories (ABT) merger. "A lot of people were hurt by that."

Meanwhile, back at the ranch, what about Delta & Pine Land (DLP), with which Monsanto has had a questionable merger deal ?

Fading as fast as the 20th century, it seems. "It looks unlikely the stock will head back up anytime soon," said Craig Karsen with Eclipse, the Chicago-based designated market maker in Delta & Pine options.

But even on a deal that's largely viewed as soggy by most of the pros, there's a way to make money. Selling Monsanto put options is one.

A put option is a contract between the buyer and seller that gives the buyer the right to sell a stock or an index at a predetermined time in the future. A put seller, however, takes in a premium for accepting the obligation to buy a stock or an index at the strike price. The danger is that a stock gets "put" to the seller in the midst of a free fall and she ends up paying 70 for a stock, for example, that's heading toward 55.

Let's say an investor is willing to wager that the Monsanto-Pharmacia deal won't go through, but doesn't mind owning Monsanto stock anyway on the chance it could fetch 50 in a breakup. That investor could sell puts on Monsanto as an alternative strategy to playing the merger's outcome with stock. It can be a good move if an investor thinks pessimism is overdone on any particular situation.

"Selling out-of-the-money puts could be an interesting alternative if the deal gets terminated," said Michael Schwartz with CIBC Oppenheimer in New York. Currently Monsanto's January 30 puts are trading for 7/16 ($43.75), up 3/16 ($18.75) on slim volume, while the April 30 puts are trading at 1 ($100), up 7/16 ($43.75).

"Worst case, you own the stock at the strike price, minus the premium you took in for selling option. Best case, the stock never trades at or below the strike price," and the option expires worthless, Schwartz said.

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