M&A Assignment

To: Prof. Veeresh

Sharma
Name : Udit Mangal Roll# 12PT2-!
"#$%lain the role of ar&itragers in the hostile ta'eo(er %ro)ess.
*o the+ ma'e hostile ta'eo(er easier or more di,)-lt for
&idders./
Merger arbitrage is the business of trading stocks in companies that are subject to takeovers or
mergers. Arbitrage exploits the fact that takeovers normally involve a big price premium for the
company. So long as there is a price gap, there is potential for sizable rewards. ut betting on
mergers can be risky business.
What Is Merger Arbitrage?
Arbitrage involves purchasing an asset at one price for an immediate sale at a higher price.
!hus an arbitrageur " a term for the person who buys the stock at the lower price " tries to profit
from the price discrepancy. #t is fairly rare to find potential opportunities for arbitrage in an
efficient market, but once in a while, these opportunities do pop up.
Merger arbitrage $also known as %merge"arb%& calls for trading the stocks of companies engaged
in mergers and takeovers. 'hen the terms of a potential merger become public, an arbitrageur
will go long, or buy shares of the target company, which in most cases trade below the
ac(uisition price. At the same time, the arbitrageur will short sell the ac(uiring company by
borrowing shares with the hope of repaying them later with lower cost shares.
#f all goes as planned, the target company)s stock price should eventually rise to reflect the
agreed per"share ac(uisition price, and the ac(uirer)s price should fall to reflect what it is paying
for the deal. !he wider the gap, or spread, between the current trading prices and their prices
valued by the ac(uisition terms, the better the arbitrageur)s potential returns.
A simple expression of a risk arbitrager*s annualized return $+A+& is as follows,"
RAR= GSS/I x (365/IP)
where,
+A+ - +isk Arbitrage +eturn
.SS - .ross Stock Spread - /ffer 0rice" Market 0rice
# - #nvestment by Arbitrager
#0 - #nvestment 0eriod $days between investment and closing date&
MDI- Management Development Institute, Gurgaon Page 1
M&A Assignment
To: Prof. Veeresh
Sharma
Name : Udit Mangal Roll# 12PT2-!
A Successful Merger exa!le"
1et)s look at an example of how a successful merger arbitrage deal works in practice. Suppose
A2 2o. is trading at 345 per share when 678 2o. comes along and bids 395 per share " a
:9; premium. !he stock of A2 will immediately jump, but will likely soon settle at some price
higher than 345 and less than 395 until the takeover deal is approved and closed. <owever, if it
trades at a higher price, the market is betting that a higher bidder will emerge.
1et)s say that the deal is expected to close at 395 and A2 stock is trading at 34=. Seizing the
price"gap opportunity, a risk arbitrageur would purchase A2 at 34>, pay a commission, hold on
to the shares, and eventually sell them for the agreed 395 ac(uisition price once the merger is
closed. ?rom that part of the deal, the arbitrageur pockets a profit of 3: per share, or a 4; gain,
less trading fees. ?rom the time that they are announced, mergers and ac(uisitions take about
four months to complete. So that 4; gain would translate into a @:; annualized return.
At the same time, the arbitrageur will probably short sell 678 stock in anticipation that its share
price will fall in value. /f course, the value of 678 may not change. ut, oftentimes, an
ac(uirer)s stock does fall in value. #f 678 shares do fall in price from 3@55 to 3A9, for example,
the short sale would net the arbitrageur another 39 per share, or 9;.
?rom the time that they are announced, mergers and ac(uisitions take about four months to
complete. So the 4; gain from target)s stock and the 9; gain from the ac(uirer)s stock together
would translate into an impressive annualized return of :=; $less transaction costs& for the
arbitrager.
Ris#s I$%&l%e'
'hile this all sounds fairly straightforward, it is assuredly not that simple " in real life, things
don)t always go as predicted. !he entire merger arbitrage business is a risky one in which
takeover deals can fizzle and prices can move in unexpected directions, resulting in sizable
losses for the arbitrageur.
!he biggest factor that increases the risk of participating in merger arbitrage is the possibility of
a deal falling through. !akeovers can get scrapped for all kinds of reasons including financing
problems, due diligence outcomes, personality clashes, regulatory objections or other factors
that might cause the buyers or seller to pull out. (&stile bi's are also more likely to fail than
friendly ones. !he longer a deal takes to close, the more things can go wrong to scuttle it.
2onsider the conse(uences of the 678"A2 deal falling through. Another company might make
a bid for A2, in which case its share value may not fall by much. <owever, if the deal collapses
with no alternative bids being offered, the arbitrageur)s position in the target company would
probably fall in value, back to the original 345 price. #n that case, the arbitrageur loses a
whopping 3> per share $or roughly @B;&.
MDI- Management Development Institute, Gurgaon Page 2
M&A Assignment
To: Prof. Veeresh
Sharma
Name : Udit Mangal Roll# 12PT2-!
/n the other hand, the behavior of the ac(uirer)s stock is less predictable in the event of a
scuttled takeover. !he market might interpret the blown deal as a big loss for 678, and its
shares might fall in value, say from 3@55 to 3A9. #n this case, the arbitrager would gain 39 per
share from short selling 678)s stock. <ere, short selling the ac(uirer)s stock would act as a
hedge, offering some shelter from the 3>"per"share loss suffered on the target)s stock.
A failed deal " especially one where the ac(uirer has bid an excessively high price " might be
cheered by the market. 678)s share price might return to 3@55 or it may go even higher, to
3@59, for example. #n this case, the arbitrager loses 3> per share on the long trade and 39 per
share on the short trade, for a combined loss of 3@C.
'ith short positions offsetting long positions, merge"arb deals are supposed to be fairly safe
from broad stock market volatility, but in practice that)s not always the case. A bull ar#et can
push up the share value of the target company, making it too pricey for the ac(uirer, and push
up the price of the ac(uirer, creating losses on the short selling end of the arbitrage deal.
A bear ar#et can always create problems. During the :555":55@ market crash, arbitrageurs
suffered hefty losses. #f A2 and 678 had been engaged in a takeover deal during that time,
the stock prices of both would have dropped. #t is likely that A2 would have fallen more than
678, because 678 would have withdrawn its offer as market optimism dried up. #f arbitrageurs
had not hedged by short selling 678 stock, their losses would have been even greater.
!o offset some of the risk, arbitrageurs mix"up traditional moves, sometimes shorting ac(uisition
targets and going long the ac(uirer, then selling calls on target shares. #f the merger falls apart
and the price falls, the seller profits from the price paid for the callE if the merger closes
successfully, the call reflects much of the difference between the current price and the closing
price.
R&les &f Arbitrageur"
Pr&%i'i$g li)ui'it*" merger arbitrageurs provide li(uidity that target shareholders
demand to avoid blow"up risk.
Aeli&rati$g shareh&l'er h&l'+&ut !r&bles" Arbitrageurs round up free float shares
in the market, making the coordination problem less severe.
I$f&rati&$ re%elati&$" #s another higher offer forthcomingF 'hat is the probability of
deal failureF
MDI- Management Development Institute, Gurgaon Page 3
M&A Assignment
To: Prof. Veeresh
Sharma
Name : Udit Mangal Roll# 12PT2-!
(&stile ,a#e&%er"
!he mood of the offer seems to be the most important determinant of the takeover outcome.
'alkling $@A>9& reports that the hostile bids have about CC; lower chance to go through
compared to the friendly bids. ?ollowing are the key characterstics of hostile takeovers,"
!he target management oppose to the offer
Mostly are off"market purchase, can turn friendly and vice"versa.
<ostile threats have a disciplining effect on target)s managers but also bring higher
premium $benefit for target&.
<ostile carry element of surprise, allow bidder to take advantage of poor target valuation,
reduce the likelihood of competing bidders, limit hold"out problems $target)s board play
for time&, bypass highly entrenched board, create pressure for board to go back to the
negotiation table $opportunistic benefits for ac(uirer&.
-&sts"
o not much due diligence
o 0rotracted $lasting longer than expected&, difficult to win control, high premium.
o !ougher merger integration ""G to withstand adverse conditions, lots of difficulties,
re(uires great efforts.
MDI- Management Development Institute, Gurgaon Page 4
M&A Assignment
To: Prof. Veeresh
Sharma
Name : Udit Mangal Roll# 12PT2-!
*o the+ ma'e hostile ta'eo(er easier or more di,)-lt for
&idders.
?rom the bidder*s perspective, the fact that shares become concentrated into the hands of
arbitragers is a positive development. !hese shareholders have no loyalty to the target and
actually want the deal to be completed. !he greater their holdings, the more the bidder can
count on being able to readily purchase the necessary shares to complete the deal.
#n years past, it was a foregone conclusion that a target company under attack for a hostile
takeover would be sold. !oday, however, with the numerous defenses that can be utilized, the
outcome is not always that clear.
<ostile takeovers usually begin with a cash tender offer. !he tender offer is announced in a
press release, and advertisements are placed in local newspaperH journals, to inform the target
company*s shareholders of the impending offer. Some hostile takeovers take the form of an
exchange offer. !he offshoot of these types of transactions is that the ac(uiring company
actually makes an offer public but does not formally launch a tender or exchange offer. !hey
make the offer through press releases and directly to the company. !he decision on whether the
offer is made directly to shareholders depends on how the offer is handled. 1ately, because of
various takeover defenses, a few offers have stayed in a non"formal format for many months
prior to the ac(uiring company*s making a bid.
An ac(uiring company would always like to get the target company to agree to the takeover at
the initial price, but many other things can happen in these transactions. !he target company
could search for and find a Iwhite knightJ" a company that will come to its aid by outbidding the
ac(uiring company*s initial offer. !he white knight is usually a suitor of choice for the target
company" a sought"after protector against being taken over by an undesirable entity.
!he target company could also do some type of recapitalization or reorganization. !his may
involve buying back stock, at a premium, from its shareholders. !he target company could also
bargain with the ac(uiring company and come to some resolution" a usually, a higher takeover
price. /r, the target company could fight the hostile takeover, and this is what the arbitrager
worries about. #f a target company fights, the arbitrager must make a determination,"
#s the fight*s only purpose to stall for time until a white knight is found or a better deal is
negotiatedF
#s the target company sincereF
Does it simply want to remain independent and not sell out to anyoneF
Arbitrageurs and shareholders alike look for a target company to defend itself against a hostile
bid with a strategy that will yield the highest possible rate of return on their investment. !he
arbitrageur*s job, in hostile takeover attempts, is to try to determine which, if any, of the
MDI- Management Development Institute, Gurgaon Page 5
M&A Assignment
To: Prof. Veeresh
Sharma
Name : Udit Mangal Roll# 12PT2-!
defensive strategies the target company*s oard may employ successfully. !o formulate correct
estimates, an arbitrageur utilizes his or her experience in the field as well as input on the current
transaction and any reliable advice received from outside advisers. #ncreasingly, the arbitrageur
relies on the target company*s oard to do the right thing.
#n trying to determine the likelihood that a hostile bid will be successful, the arbitrager analyzes
numerous aspects of the target company*s business and structure. !he initial (uestion that
arbitrager must ask is, I'hat are the likely defenses that the target company can employFJ #f
there is a clear overlap in business operations, the arbitrager knows that he or she will have to
determine how great that overlap is, and whether it might create an antitrust problem for the
hostile bidder. !he arbitrager must determine, after figuring out what defenses either stalls the
transaction for a long period of time or becomes a potential stumbling block, this transaction can
be a very dangerous for the arbitragers community.
Arbitragers can influence the execution of a hostile offer. #n fact, they may even be the most
influential group in determining whether such an offer succeeds or fails. W*ser+Pratte, one of
the most well"known merger arbitragers, describes his colleagues as follows $@A>:&,
An arbitrager is not an investor in the formal sense of the world, i.e., he is not normally buying
or selling securities because of their investment value. He is, however, committing capital to the
deal- the merger, tender offer, recapitalization, etc.- rather than to the particular security. He
must this take a position in the deal in such a way that he is at the risk of the deal, and not at
the risk of the market.J
Summarizing, while arbitragers seem to maximize their returns, they do dilute the shareholding
and thus help hostile takeovers. ?allout is clearly out of interest of both an arbitrager and the
hostile bidder. As an arbitrager, it is therefore essential to have a good knowledge of the parties
involved and to attempt to anticipate their respective conduct.
MDI- Management Development Institute, Gurgaon Page 6
M&A Assignment
To: Prof. Veeresh
Sharma
Name : Udit Mangal Roll# 12PT2-!
R./.R.0-.S
Books:-
Melka 1ionel, Shabi Amit, Merger Arbitrage" A /u$'ae$tal A!!r&ach t& .%e$t+1ri%e$
I$%esti$g, :5@C, published by Kohn 'iley L Sons, #nc
Moore Meith M., Ris# Arbitrage" A$ I$%est&r2s Gui'e, @AAA, published by Kohn 'iley L Sons,
#nc.
Mirchner !homas, Merger Arbitrage" (&3 t& Pr&fit fr& .%e$t+1ri%e$ Arbitrage, :55A,
published by Kohn 'iley L Sons, #nc
Websites:-
http,HHmburmansyah.blogspot.inH:5@CH5BHhostile"takeover"defensive"strategies.html
http,HHwww.investopedia.comHarticlesHstocksH5BHmergerarbitrage.asp
MDI- Management Development Institute, Gurgaon Page 7