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Cisco, Splunk, and Arbitrage Investing: Is the Upside Still There?

Motley Fool - Tue Oct 3, 2023

On Sept. 21, Cisco (NASDAQ: CSCO) announced its intentions to buy Splunk (NASDAQ: SPLK). The deal is for $157 per share in cash, but Splunk's stock only trades for $145 per share now.

That represents around an 8% upside for Splunk shareholders before the deal closes. So that prompts the question: Should investors buy Splunk stock for the 8% gain? This is known as arbitrage investing, which occurs when an investor purchases an asset for less than it's publicly worth. So, is this arbitrage opportunity worth it? Or is it time to move on from Splunk stock? Let's find out.

The deal still has some hurdles to clear before going through

According to the press release, the deal is expected to close by the third quarter of 2024. However, the acquisition has some hurdles to clear before then. First, Splunk shareholders must approve the acquisition before it can move on. While rare, it's entirely possible this group could reject the deal, ending the acquisition talks or forcing one side to come back with a better offer.

This might be on the table for Splunk shareholders, as the $157 buyout price is nowhere near where the stock traded during 2020 and 2021 (it maxed out at nearly $225 per share in 2020). The deal also values Splunk at 6.7 times sales, which is rather cheap for a company growing its sales at a 14% clip. So, investors shouldn't discount Splunk shareholders rejecting the deal, which is one reason it doesn't trade at $157 per share right now.

Should Splunk's shareholders approve the deal, it could get hung up in regulatory approvals. This happened with the Microsoft and Activision Blizzard deal. This deal was announced on Jan. 18, 2022, and has yet to go through nearly two years later. Regulatory authorities in the U.S., U.K., and European Union have all sought to block this acquisition on anti-competitive terms. However, Microsoft is still working on closing this deal by making varying concessions in the approval process.

Cisco may have to do the same with Splunk, although this is unlikely due to many cybersecurity competitors to the combined entity. Splunk's data monitoring service combined with Cisco's data center products creates a more encompassing solution for customers -- not an anti-competitive one. Plus, with other companies like Datadog in the space, there are plenty of alternatives.

If Cisco and Splunk can clear these hurdles, the acquisition will go through. However, does that mean investors should buy the stock for the 8% upside?

Is an 8% upside really worth it?

Because Splunk's current price is only 8% below the buyout price, the market thinks there is a pretty good chance that this deal will go through. But, with the Q3 of 2024 closing date, investors will wait a long time to be paid.

As a result, investors may actually lose money by buying and holding Splunk until the official buyout, as the market may rise before then. Let's take a look at Activision Blizzard, for example.

When the acquisition by Microsoft was announced, the stock traded for around $82 per share, or 14% below the buyout price of $95. Now that the U.K. has given the acquisition its approval the deal will likely go through, so the stock trades at $94. From the start of 2022 to now, the market significantly dipped and is still down from its highs set in early 2022. So, holding Activision Blizzard shares has essentially been like holding cash.

ATVI Chart

ATVI data by YCharts

This won't be the case every time, as the market may move higher if you decide to hold Splunk shares for the 8% upside. Or it may move lower, and the 8% upside is an excellent investment.

Many hedge funds participate in arbitrage investments for this reason, as it balances risk. But, with the relatively little upside and long closing period, I think investors are better off looking elsewhere in the market, as there are several stocks with greater than 8% upside over the next year that investors should be considering instead.

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Keithen Drury has positions in Datadog. The Motley Fool has positions in and recommends Activision Blizzard, Cisco Systems, Datadog, Microsoft, and Splunk. The Motley Fool has a disclosure policy.

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