As the Hopes and Worries Continue...

Shares of America Online and Time Warner fell again Wednesday, as doubts about their marriage continued to weigh on the stocks.

But by one measure those concerns have lessened since the deal was announced on Monday, some traders said.

After tumbling early Wednesday, shares of AOL and Time Warner recovered somewhat in late morning, then drifted lower in the afternoon. Including after-hours activity, AOL ended off $3.94 at $60.06, the lowest close since Oct. 27.

AOL stock now has fallen 36% since its record close of $94 on Dec. 13, and is down 18.6% from last Friday’s close.

Time Warner fell $6.38 to $79.63 on Wednesday, including after-hours action. The price has slumped 13.6% from Monday’s record close of $92.25, though it remains 23% above last Friday’s close.

At current prices, the deal is worth $90.09 in AOL shares to Time Warner holders. They would get 1.5 shares in the new firm for each Time Warner share.

Time Warner’s market price is now about 12% below the indicated deal value. But that is a smaller difference than the 15% spread at the end of Monday’s trading--suggesting lessened concern about the final outcome.

Nonetheless, risk arbitragers--investors whose business is betting on the outcome of proposed mergers--are more leery of the deal than the applause from some money managers might indicate, some prominent “arbs” say.

These professional speculators believe that there is a serious threat of antitrust action to halt or modify the deal. They also say that having an Internet firm as a buyer presents special problems.

What’s more, with the closing date of the deal perhaps a year away, the profit potential in taking a chance on Time Warner shares--the normal role of arbs--is currently uninspiring, some say.

Risk arbs are a secretive breed who toil at big securities firms or at boutique investment houses, trying to profit on the “spread” between the current share price of a target firm and the final purchase price.

Arbitrage activity tends to tighten such spreads, as confidence rises in the likelihood of a deal’s being completed.

However, Peter Schoenfeld, chairman of P. Schoenfeld Asset Management, a risk-arbitrage firm in New York, said that he doubted many of his fellow arbs were betting heavily on AOL/Time Warner. He guessed that the spread was more likely being tightened by money managers who believe the merger is a “done deal.”

Guy Wyser-Pratte, another prominent Wall Street arb, said it would be foolish for investors to ignore the chance of regulatory intervention. He considers top Clinton administration antitrust officials prone to attacking high-profile deals to score political points.

The classic risk-arbitrage strategy is to purchase the stock of the target company--Time Warner, in this case--and simultaneously “sell short” stock of the acquirer, AOL. (A short sale is the sale of borrowed stock in hopes that its price will fall and the borrowed shares can be repaid with cheaper stock later.)

The strategy is meant to exploit the fact that in most deals, the target’s stock eventually rises to meet the indicated deal value, while the buyer’s shares often remain under pressure.

But if the deal fails to close, the damage can be considerable, particularly when a volatile Internet stock such as AOL is involved, arbs say. If the deal crumbled because of the opposition of AOL investors, for example, AOL shares could explode in a relief rally, murdering arbs who had sold the stock short. Time Warner, in turn, could plummet.

As a rule of thumb, arbs say, the gross profit margin will be about the same as the spread at the time of the investment. Thus, a 12% spread on a deal that closes in a year will produce a 12% return before expenses.

Given the risk, Schoenfeld said, a 12% gross profit on the AOL/Time Warner deal “would be a pretty pedestrian return.” Hence, though his firm invested in the deal when it was announced Monday, “we’ve reduced our position.”

J. Michael Kelly, AOL’s chief financial officer, told The Times on Wednesday that AOL sees no major regulatory issues impeding the deal. Nor, he said, is there any agreement to renegotiate terms of the deal if AOL stock falls to a particular level.

Kelly said that in his discussions with big AOL investors, “We’re making sure they understand when the synergies are going to come. We’re walking people through that.”

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How Low Will They Go?

Shares of new merger partners America Online and Time Warner continued to sink on Wednesday.

Daily closes on the NYSE:

Source: Bloomberg News