Focus Media Holding Limited (FMCN) has been devastated by the recent economic downturn.  In late 2007, the stock topped out above $65 per share, but currently trades at roughly $7.50 – down roughly 88% from its former glory.  The Chinese advertising company spent considerable capital to develop a network of outdoor advertising monitors which held promise to generate huge revenues due to exposure to the Chinese masses.

But as the economy weakened and advertisers pulled back on spending, Focus Media found themselves leveraged and without the necessary revenue to keep up with expenses.  Finally, the company had no choice but to sell the majority of its assets to rival Sina Corporation (SINA) in a stock deal that should close in the next few months.  Focus Media will still continue to trade as a stand-alone company, but after selling its best assets, it is unclear just how the company will survive.

While the long-term concerns surrounding Focus Media are still very difficult to overlook, there is an interesting opportunity to lock in a profit from the proposed merger.  Focus Media has said that it will receive 47 million shares of SINA as compensation for the outdoor advertising assets.  The company plans to distribute these shares to holders of FMCN once the transaction is complete.

Focus Media has roughly 128.6 million shares outstanding and will be receiving the 47 million SINA shares to distribute.  At this point it looks like each share of FMCN will have rights to 0.365 shares of SINA.  So if you own 1,000 shares of FMCN you can expect to receive 365 shares of SINA.  Using today’s market prices, it looks like the value of these SINA shares actually represent $10.71 for every FMCN share.  However, FMCN is currently trading at just $7.60.  So in theory, you could buy 1,000 shares of FMCN at the current price, short 365 shares of SINA at $29.00 and expect to make about $3.00 once the deal is complete.

Another alternative for this trade would be to buy 1,000 shares of FMCN and then sell 3 calls SINA September 30 for $2.70  If SINA trades flat to lower from current prices, you will be able to keep the premium and eventually sell your SINA shares at the market.  However, if SINA trades higher, you will be obligated to sell 300 shares at $30, but you should benefit from a rise in FMCN because the payment for its transaction will be worth more.

While the transaction appears riskless on paper, one should realize that no profit comes completely free of risk.  The wild card in this scenario is two-fold.  First, there could be some regulatory resistance to the deal and if SINA were blocked from purchasing these assets, FMCN would likely trade even lower and it’s possible that SINA could trade higher as investors no longer fear dilution from the deal.

The second risk is that FMCN could accept the shares and then fail to distribute them to investors.  While there would certainly be a large public outcry against this, it wouldn’t be the first time executives changed course mid-way through an important transaction.  If FMCN were to continue to hold the SINA shares, the value would still be available to investors, but the spread could still remain wide as investors fear the company will sell the SINA shares instead of turning them out to investors.  This would be bad news since Focus Media is bleeding cash without these assets and could quickly burn through the proceeds from the SINA sale.

So the opportunity to profit from this transaction is very attractive and could be a lucrative opportunity.  But investors need to be aware of the risk and keep the size of this trade at a reasonable level in case the deal falls through.

FD: Author does not have a position in FMCN or SINA

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