Marvell Agreed to Pay $1,132 a Share for Lumentum. The Stock Trades Near $510. Here's Why It’s Not as Good As It Looks.

When Marvell Technology (NASDAQ:MRVL) agreed to acquire Lumentum (NASDAQ:LITE) on Nov. 2, the deal valued Lumentum at about $1,132 per share, a roughly 24% premium over its pre-talks trading price. Three days later, Lumentum closed at about $510.

That's not quite the bargain it seems. Even based on the current value of Marvell's offer, Lumentum trades at about 85% of what it would be worth if the deal closes, a gap of about 15% (we'll discuss why we say "current value" in a bit). Here's why that gap exists, and why I don't think it's free money.

Image source: Getty Images.

The deal's value keeps shrinking

First of all, Marvell is paying for Lumentum entirely in stock. The acquisition price is well over $100 billion (based on Marvell's share price before the announcement), and acquiring Lumentum for cash simply wouldn't be practical. Lumentum shareholders will receive 4.5 Marvell shares for each share they own when the deal closes. There's no collar, a feature some deals use to protect sellers if the buyer's stock falls. So every $1 drop in Marvell's share price cuts $4.50 from the deal's value for Lumentum investors.

Marvell's stock has fallen sharply amid recent market turbulence. It closed at $133.55 on Nov. 5, which puts the offer at about $601 per Lumentum share. That's far less than the $913.95 Lumentum traded for before the deal talks became public. In other words, the premium Lumentum shareholders were promised is gone, at least for now, because it is 100% dependent on Marvell's stock price.

This could take a while

Here's a big reason why there's still a gap, even below the new, lower value of the deal. The companies don't expect to close the deal until the first half of 2028, and the merger agreement allows extensions as late as August 2028 if regulators are still reviewing it. If the deal closes, Lumentum's stock would be worth exactly 4.5 times what Marvell shares are. But spread over that much time, a 15% gain works out to roughly 8% to 13% annualized returns by my estimate, depending on when the deal closes. And the deal closing isn't exactly a sure thing.

Regulators are the biggest wild card. Bank of America downgraded Marvell after the announcement, citing a long review process "that includes China." There's good reason for concern. China's regulator never approved Intel's (NASDAQ:INTC) planned acquisition of Tower Semiconductor (NASDAQ:TSEM), which collapsed in 2023. Even deals that do get approved can take a long time. Synopsys' (NASDAQ:SNPS) acquisition of Ansys took about 18 months to clear.

If the deal falls apart, Marvell would owe Lumentum a $3.2 billion termination fee. That sounds like a lot, but it works out to roughly $35 per Lumentum share, a small cushion for a stock trading above $500.

What this means for investors

Professional arbitrage investors typically buy the target and short the acquirer's stock to lock in the spread. And in this case, it might seem like a good idea for your portfolio. After all, 15% is quite a gap on an already beaten-down stock. Most individual investors shouldn't be doing that. Without that hedge, buying Lumentum today is largely a bet on Marvell's stock, with regulatory risk layered on top.

To be fair, Lumentum would be fine on its own. Its revenue grew 137% last quarter, and management expects more growth this quarter. In a nutshell, if the deal breaks, the stock wouldn't necessarily collapse.

Having said all that, if I wanted exposure to this deal, I'd rather own Marvell directly than buy Lumentum and hope the spread closes. The gap between Lumentum's price and the offer isn't a mistake. It's the market's price for time, uncertainty, and Marvell's own volatility.

Matt Frankel, CFP® has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Intel, Lumentum, Marvell Technology, and Synopsys. The Motley Fool has a disclosure policy.