Two Seemingly Unrelated Market Events On Opposite Sides Of The Globe Have A Hedge Fund Manager Believing A Merger Between Yahoo And AOL Could Happen Any Day Now

Data courtesy Marc Imhoff of NASA GSFC and Christopher Elvidge of NOAA NGDC. Image by Craig Mayhew and Robert Simmon, NASA GSFC

Yesterday, amid countless market transactions across the globe, there were these two events:

• In the US, a single investor bought $1 million worth of soon-to-expire AOL stock options.

• In Asia, the stock price of Yahoo! Japan suddenly surged.

These two events may seem unrelated to you and me, but in Canada, an attentive hedge fund manager saw them and began to believe - or at least hope - that a major merger he's been long waiting for is about to happen.

That hedge fund manager is Eric Jackson. Jackson has been running a small hedge fund out of Toronto since 2007. It's called Ironfire Capital. One of Ironfire's biggest positions over these past seven years has been a stake in Yahoo. Lately, Ironfire has also taken a stake in AOL.

This is because Jackson believes that AOL will soon be acquired by Yahoo.

Now, I'm writing a book about Yahoo and I've been covering AOL for a very long time. I have to say, if Jackson were right, it would be very surprising to many my sources.

Through my reporting, I've learned that yes both companies have explored this kind of deal in the past. But I've also learned that AOL CEO Tim Armstrong doesn't want to work for Yahoo CEO Marissa Mayer amd that he loves running a public company.

Sources are also skeptical that Mayer thinks the way to turnaround Yahoo is to buy a company that has many of Yahoo's problems, just on a smaller scale.

So, my guess is that an AOL-Yahoo deal is not imminent.

But I've been wrong before, and it's very interesting to hear why Jackson believes the deal should happen.

It's even more interesting to hear why he thinks yesterday's market events indicate a deal may happen soon. It's a type of tea leaves reading that's foreign to me. It's a fascinating look into how the mind of a professional trader works.

Here's why Jackson thinks the deal should happen:

Jackson told me he believes that Yahoo would benefit from adding AOL's media brands, particularly The Huffington Post, and from adding AOL's online video advertising business. Jackson also thinks the merger would create lots of costs savings for the combined companies. For example, after AOL and Yahoo merged, it would only need one sales force instead of the two it has now.

Here's why Jackson believes a deal could be happening soon:

First, there's the options trade. Yesterday afternoon, Jackson noticed that another trader had acquired $1 million worth of AOL April $55 calls at $1.50 per option. On the phone, Jackson explained to me that what that means is someone made a $1 million bet that AOL's share price will be above $56.50 by the third week of April. Jackson told me that for every $6 the stock price goes above $56.50 by then, the trader will get a 4X return on investment. If AOL's share price is not above $56.50, the $1 million goes away. Jackson says "it's a pretty bullish bet," and he wonders if whomever made it has some "inside knowledge" about a deal coming soon.

Then there's the spike in Yahoo! Japan's share price. This is even more complicated.

It all starts with the fact that Yahoo! Japan is a joint venture between Yahoo, the American company that trades under the symbol YHOO, and Softbank, a big investment firm run by a genius capitalist named Masayoshi Son.

For years now, Softbank was been trying to buy Yahoo's stake in Yahoo! Japan. But Yahoo has been reluctant to take Softbank's cash because the deal will result in Yahoo paying a huge tax bill on its profits. Back in 2011, however, Yahoo and Softbank discovered a type of deal that would allow Yahoo to get around paying taxes on its windfall.

The deal is called a "cash-rich split." In this type of deal, Softbank would acquire a company and give that company, plus cash worth up to 66% of that company's value, to Yahoo in exchange for Yahoo's stake in Yahoo! Japan.

So what does this all have to do with Yahoo! Japan's share price spike?

Well, if Yahoo were to ever sell its stake in Yahoo! Japan to Softbank, Softbank would almost immediately "retire" those shares. Subsequently, the remaining shares in the company would immediately rise in price. (Why? Think about a company as a pie, and each share as a slice. Each slice is bigger if the pie is divided six ways rather than eight.)

So…when Eric Jackson saw Yahoo! Japan's price spike yesterday, he wondered if the reason was because insiders believe Yahoo is about to sell it's stake in Yahoo! Japan back to Softbank, and these insiders were seeking to take advantage in an almost certain price increase in the stock.

Then Jackson thought: If that's happening, the only way it would happen is if a cash-rich split deal were going through.

Then Jackson thought: the most logical company for Softbank to acquire and trade to Yahoo (along with cash) would be AOL.

And then, when Jackson saw that a trader had made a very aggressive all or nothing $1 million bet that AOL stock will go up a lot before April, it all suddenly came together.

Amid the noise of countless market transactions across the globe, two clear signals pulsed out at him.

Which is about when he tweeted: