By The Arbitrage Fund

This article has been provided by the Arbitrage Fund which describes many of the issues considered in merger type deals and how to arbitrage them. In previous Arbitrage Corners, different types of deal structures: cash for stock, stock for stock, collars, etc. have been discussed. It is important to walk through some of the many considerations that go into analyzing a merger arbitrage situation and determining whether and when to establish a position. This is by no means an exhaustive list and is primarily a discussion of the research as opposed to trading aspects of a position, but should provide some insight into how to analyze a merger situation.

Typically, a deal is announced through a press release issued by the participants to the deal, followed by a conference call with analysts and investors. It is from this that the portfolio managerís team will first learn three critical pieces of information about the deal: (1) the terms and conditions; (2) the logic behind the deal and how it was priced; and (3) managementís best guess as to timing to close the transaction which is then broken out into a more detailed timeline. On the conference call, the arbitrageur will also hear for the first time the marketís reaction to the deal as major shareholders and analysts voice their opinions in Q&A following managementís presentation.

Key deal terms and conditions include:

  • the price/ratio for the "merger consideration"
  • the form of the consideration (i.e. cash, stock, combination)
  • whether there is a collar (adjustment to stock ratio as acquirerís stock price moves)
  • if the agreement offers stock and cash alternatives, whether there are any caps or minimums on the amounts of stock or cash available in the deal

Key conditions to look for include:

  • Regulatory approvals needed including SEC, Federal Trade Commission/Dept. of Justice (both relating to antitrust), foreign antitrust or SEC equivalents, industry specific (FCC for telecom, PUCHA for utility, bank regulators, etc.); CFIUS (Committee on Foreign Investment relating to national interest), state regulators
  • Shareholder approvals needed on the target and/or acquirer sides, what percentages are required, multiple or supervoting classes of shares, preferreds, bondholder consents, and any pre-arranged voting agreements
  • Financing conditions: These may be part of the merger agreement or imposed by lenders through Commitment Letters. Financing conditions may include various earnings or EBITDA and debt multiple based tests.
  • Material Adverse Change clause and carveouts from what "counts" in that definition
  • Termination rights and associated fees
  • Ability of the target company to solicit or consider other offers
  • Ability to pay dividends over the course of the transaction
  • "Drop dead date" after which parties may withdraw from the deal
  • Any special conditions such as litigation, environmental, ERISA, appraisal rights

Each of these gives the arbitrageur insight into the deal, its risks and its timeline. Of course, knowing the conditions is just a starting point and a careful analysis of, for example, any potential antitrust or financing issues will need to be performed both before and during the "life of the deal."

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