Thursday, September 3, 2015

Market Swings and Mergers: Protecting the Deal and Arb Opportunities

The recent market swings and declines impact mergers in many ways.  Let's consider two.  First, we have the parties involved in making a deal.  These are numerous, but for convenience let's just focus on the firm to be acquired (target) and firm doing the acquiring (bidder).

If cash is the form of payment and a fixed price is set, target shareholders are in a fairly secure position.  I say fairly, because extreme swings can threaten any deal (e.g. Dow Chemical's Acquisition of Rolm and Hass right after the 2008 market crash).  The bidder may nevertheless squirm as market shakeups impact the value of the target and the related projection of future cash flows.

In stock deals, things get more interesting.  Suppose, for example, a deal is set with a one to one stock swap.  If the price of the target changes relative to the price of the bidder, the value received and paid can be quite different than originally envisioned.

One way to mitigate this risk is the use of collars - essentially boundaries framing a range of values in which a deal will take place, depending on the price of the shares at closing.  This can offer upside protection to a bidder (a maximum payment or ceiling) and downside protection to a target (a minimum payment or floor).  For more detail on this, see our previous post Acquisition Risk, Collars, and the Time Warner Deal.

Another group active in mergers and affected by market swings are merger arbs, essentially trying to buy at one price, sell at another and minimize the risks.  For example, the Beta of The Merger Fund (MERFX) is 0.08 - taking close to zero market risk.  Again, see our related post Speculation Spreads and the Market Pricing of Proposed Acquisitions.

However, volatility and market dips can widen spreads and make arbitrage opportunities more attractive.  This works particularly well if, as mentioned, the arbs can appropriately hedge market (and where possible, deal) risk.  An interesting example of this comes from The Deal's post Stock Market Volatility Creates Opportunities for Merger Arbs.

All the best,


No comments:

Post a Comment