Some people have asked me why the share price is trading as high...

Some people have asked me why the share price is trading as high as $1.40 today. I thought I would post my explanation in case anyone is curious.

I have heard one theory that it is greenmailers or existing shareholders looking to build a 10% stake to prevent Cephalon reaching 90%. I'm pretty sure that isn't it, but rather a new trading strategy by our friendly neighbourhood hedge funds.

Hedge funds that have already accepted for their holdings stand to make $1.35 per share if the offer closes below 90%, or $1.40 if it closes above 90%. So they have a big incentive to help Cephalon reach 90%.

With potential to earn an extra $0.05 on every share already tendered, it makes sense to pay up to $1.40 on additional shares and accept them into the offer to help push it above 90%. ie. even though they are not making any money on the shares bought at that price, they will make a bigger profit on the shares they already tendered.

To take a simple example, say a hedge fund has already tendered 1m shares it acquired at $1.37 per share. It buys an extra 100,000 shares on the market at $1.40 today.

The hedge fund's P&L looks like this if the offer closes below 90%:

1 million shares
revenue $1.35 * 1 million = $1,350,000
less expense $1.37 * 1 million = ($1,370,000)
profit / (loss) on trade = ($20,000)

100,000 shares
revenue $1.35 * 100,000 = $135,000
less expense $1.40 * 100,000 = ($140,000)
profit / (loss) on trade = ($5,000)

Total profit / (loss) = ($25,000)

BUT if the offer closes above 90% the P&L looks like this:

1 million shares
revenue $1.40 * 1 million = $1,400,000
less expense $1.37 * 1 million = ($1,370,000)
profit / (loss) on trade = $30,000

100,000 shares
revenue $1.40 * 100,000 = $140,000
less expense $1.40 * 100,000 = ($140,000)
profit / (loss) on trade = nil

Total profit / (loss) = $30,000

So by risking an extra $5,000 loss in this example they can swing their P&L by $50,000 from a loss to a profit. If the hedge funds think there is a high chance Cephalon will get to 90% this is a good trade as it increases the probability and accelerates it.

I hope this makes sense!