Red Hat, Novell: Reading the Stock Market Tea Leaves

Novell rejects Elliott bid, will other bids come? Also, Red Hat options may mean good news.

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Spring has sprung, at least here in the Northern Hemisphere, and with it comes the blooming of flowers, the chirps of baby birds, and "Novell's Board of Directors reject[ing] Elliott Associates' unsolicited, conditional proposal as inadequate."

Ah yes, lovely Spring. And while Novell stiff-armed Elliott, what's going on with Red Hat's stock, which is seeing unusual options activity in the days ahead of its next earnings call?

Why Novell waited until Saturday to announce the news is anyone's guess, but since I can be classified as anyone, let me take a shot: rejecting what on the surface seemed a pretty solid bid as far away from stock market times as possible will will help alleviate any potential blow NOVL's stock price this morning when the NASDAQ opens. Though, in early market trading this morning, NOVL was up, so perhaps that blow isn't coming.

Why not? One possible reason why NOVL's stock is climbing: the market still sees its value as a potential acquisition target. There's still about $1 billion in cash sitting around in Novell's coffers, plus a growing (albeit slowly) Linux business, and Elliott isn't the only shark in the sea. Certainly Novell is open to the option of getting bought, as outlined in Saturday's press release:

"Novell also announced that its Board of Directors has authorized a thorough review of various alternatives to enhance stockholder value. These alternatives include, but are not limited to, a return of capital to stockholders through a stock repurchase or cash dividend, strategic partnerships and alliances, joint ventures, a recapitalization and a sale of the Company."

It's important to note that this is the sort of thing that Novell has to say for the benefit of its stockholders: you don't just reject a $2 billion-plus takeover bid out of hand without assuring the stockholders that you have their best interests at heart. That's what public companies have to do. We'll see if anyone bites the hook Novell just cast.

Another duty public companies need to perform is the quarterly earning announcement. For Red Hat (RHT), the next such announcement is made on March 24. Not only is this the quarterly announcement, but it's the end of Red Hat's fiscal year, as well.

What's very interesting is that lately the volume of put and call options traded for Red Hat stock has shot up significantly, which could be a sign of positive things to come for Red Hat.

A put option is an investment instrument where the buyer thinks the the price of a stock will drop soon, and so retains the option to sell the stock at the current (higher) price if the stock drops before the expiration date of the option contract. A call option is the opposite: expecting a stock's value to rise, the buyer can take out the option to buy the stock at a set (lower) price now, and if the stock does increase by the expiration date, they can buy it at the lower price (and likely turn around and sell it for a profit.)

In recent days, this type of options trading has shot up in volume for RHT, with the ratio of put/call options being low (around 0.14). A low put/call ratio means that in general, investors are bullish about the actual stock's future and want to cash in on an expected rise in stock price. So, if these options investors are right, then good news may be coming for Red Hat.

Of course, what the good news is may be a bit of a guess in itself. Very likely, given the timing of this unusually high-volume options trading, investors are expecting better-than-predicted earnings from Red Hat in their Wednesday announcement. There is a chance, albeit small, that this could be current Red Hat stock holders expecting bad news and trying to protect their current holdings. But, if that was indeed the expectation, there would be more puts than calls, so I doubt it.

If this sort of volume were at any other time, it could be a indicator that Red Hat may be an acquisition target itself. Indeed, there was a options volume alert on March 4, two days after Elliott announced its bid for Novell, when "there were 13,316 call contracts traded compared to the [then] ten-day average volume of 581 contracts." Perhaps the bid for Novell got people thinking that Red Hat might get a bid, too.

Last Friday's volume alert, call contract volume jumped up to 7,892, well over the ten-day average of 1,138 calls/day. Not as big of a jump as the March 4 increase, but still significant.

It's not clear if these two instances are related to a potential acquisition, or just individual attempts to hedge bets against potential Red Hat gains. It's likely the latter. Red Hat has made some solid moves this past quarter, not the least of which was last Tuesday's announcement that the Red Hat Enterprise Virtualization platform was chosen by IBM for its new cloud computing service. That kind of news gets earning results up.

Reading the stock market, though, is very much like fortune telling, so take all of this with a huge grain of salt. Even trying to anticipate broad trends is tricky stuff. I am only pointing out the potential for some Red Hat gains based on market activity. The reality will be revealed later this week.

As for Novell, time will tell if someone comes up with another bid. And will that bid be a better one, or was Elliott's first run the best offer?

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