A failed merger due to the dry-up of credit has put Image Entertainment in trouble.  the future of the company is uncertain and recent reports cited by the company mention that it can not survive for a long time with its existing assets and debts.

The company has sought "other alternatives" for its future, which means, in essence, it is looking to sell itself once again.  there is no telling how much the company would seek, however, due to the recent plunge the stock has taken, i am not sold on it being at a price anywhere near its former agreements.

There is a bleak picture here, and while the company has significantly cut its losses, it seems as though unless they break into the black anytime soon, it is going down.  A merger seems to be the most likely "alternative".  A sad time for the company.  Sad indeed.

Here are the top stories this week at Value Investing News: Image Entertainment (DISK) Valuation Despite Merger Failure A reader provided a detailed analysis of DISK and why it is cheap even now without the merger. A high LBO target. For Value Investors, Smaller Is Better Value investors are always looking for inefficiently priced stocks. Such stocks are often [...]

The Image Entertainment Inc. (NASDAQ GM:DISK) merger has been terminated again.[More...]

Just bought 1000 shares of Image Entertainment (DISK) at $1.10/share as a speculative arbitrage opportunity.

As a speculative play, the details about their business isn't too important to me since I'm only attempting to capitalize on the difference in the stock price now compared to the buyout price. What do I mean?

According to a definitive merger agreement in January:

On November 17, 2008, our board of directors approved, and on November 20, 2008, we entered into, a merger agreement providing for the acquisition of Image by Nyx Acquisitions, Inc., a Delaware corporation, or Nyx. If the merger is completed, you will be entitled to receive $2.75 per share in cash, without interest, for all of the shares of our common stock that you own at the time of the merger.

What is important to me are the chances of this merger actually happening.

The current stock price would indicate that most investors probably don't think this merger will ever come to fruition, and there's good reason for their skepticism. Nyx Acquisitions, Inc. has already extended the closing date of the merger a few times and investors are worried that Nyx won't be able to swing the financing or that they may back out of the deal.

But, I think differently.

With each extension of the merger closing date, Nyx is basically required to pay an ever-increasing, and non-refundable, extension cost to Image referred to as a "business interruption fee". After news today of another reported extension, the amount of extension money Nyx has paid to Image now totals $4 million.

I bought DISK because I believe NYX wouldn't just walk away from such a large deposit if they weren't truly intending to buyout Image. It's difficult finding financing at this time, but not impossible. The merger date may be postponed again, but I think that that it's a done deal sometime in the near future.

Of course it's all speculative, but when it happens, I should more than double my investment in this arbitrage opportunity. If it doesn't happen, Image Entertainment, Inc. would be "sitting pretty" with a free cash infusion of at least $4 million.

In this economic climate merger investing is a sure way to guaruntee low returns, if not negative returns.  Here's why.
Companies rarely have the capitol themselves to complete a notable merger.  Those who do (such as if Microsoft were to buy a much smaller company) then the merger would be a good bet, but at the same time, the price of the intended buyout stock would be close to the buyout price because stock investors would have seen that the deal is likely and therefore bought and sold accordingly.

Buyouts which rely on a company taking on debt and/or borrowing capitol to complete the merger is much less likely to be completed in this economic climate because of the credit crunch, or simply, that banks arent lending enough money and if they are, are lending to companies with almost guarunteed chances of remaining solvent and able to repay what they borrowed.
Therefore, when two companies agree that one will take over the other in an "all-cash" deal, or a deal in which the target companies stock will be bought by the other company for an agreed-upon price, than there are many factors which can derail such a merger before it is completed.  The more Wall St. thinks that the deal is likely to fall apart, the farther away the stock price is from the "buyout price".  this gap in price is called an 'arb spread'.  As you can infer, the higher the spread, the less Wall st. thinks the deal will go through.

In the case of Image Entertainment's pending buyout by Nyx Aquisitions, there is an arb spread that is well over 100%.  This would normally be a double--hell, even triple red light to most investors who dont like ultra-risk to stay away from DISK.  However, there are a couple of reasons that this is an opportunity that looks appealing. 

I wont go into the EPS figures or Valuation of the company right now, i am saving that for a future post, this post serves to highlight the risk-reward issue for the merger.

There are two reasons why i am drawn to this pick.  The first is because of the fact that the companies, both Nyx and Image are determined to get the deal completed.  They believe they need each other and are truly intent on finalizing the merger.  There have been numerous extension dates granted to Nyx to come up with the capitol to fund the transaction and each time there has been an investment by Nyx in the amount of millions of dollars into the account which holds the capitol to be paid out in the event the deal is nixed.  (if the deal falls apart as a result of one companies actions, the other gets paid money from this account as a compensatory measure.  it's not much, but it shows that Nyx believes it can honestly come up with the needed capitol.  otherwise they wouldnt just be throwing millions of dollars away).  Secondly is the fact that the merger has been agreed to by the shareholders.  there is nothing from a shareholder standpoint that can block this merger.  The only issue here is capitol to be raised by Nyx.
The one con in this deal is the lack of transparency with regard to just how close nyx is to raising the capitol.  it is unclear whether they have 25%, 50% 78% or even 90% of what is needed.

But, i think that the arb spread of over 100% is very appealing on a merger that is more or less a "wait and see on the capitol to be raised" front.  That is why i got in on DISK at 1.33.

Make an informed decision on this one.  If you want you can wait for my post on the valuations on the stock, but if you're considering an investment in real life, assess how much risk you can accept in this volatile market, and then make a decision.

Happy and safe investing,