A Merger Arbitrage Opportunity

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January 11, 2007 | Stocks | | Author Asif

2006 proved to be a banner year for global mergers & acquisitions with $3.79 trillion worth of deals, which even surpassed the deals made during the height of the dot com boom in 2000. As you may have noticed, when a merger or acquisition is announced, the stock of the company getting acquired usually jumps up and closes the day at a price very close to the acquisition price but often a little lower. For example when private equity firm Genstar Capital announced the acquisition of International Aluminium Corp (IAL) yesterday, the stock jumped up more than 4% to close the day at $52.08. This is almost a dollar less than the acquisition price of $53 per share in cash that Genstar is offering. Here are a few reasons why this occurs.

  • Unless there is a possibility of a rival bid, the stock of the company getting acquired will stay stagnant and tie up capital until the acquisition is completed.
  • The acquisition may not go through due to antitrust issues or breach of conditions mentioned in the deal.
  • The deal may be an all stock or stock plus cash deal and there is a risk that the stock of the acquisitor may drop in value before the acquisition is complete.
  • If it is a very large deal, there is a risk that the acquisitor may not be able to raise the required capital to complete the deal.

Investors can profit from mergers and acquisition in a variety of ways. One of these methods is called merger arbitrage where investors purchase the stock of the company getting acquired while simultaneously shorting the stock of the acquisitor (I like this word and have already used it thrice since it saves me from typing “the company making the acquisition” or something to that effect). This is best done as soon as the news of the merger or acquisition is released but is often the hardest to achieve in this era of universal and instant access to news. Another method to benefit from mergers is called risk arbitrage and is described in detail in this excellent FocusInvestor.com article called Introduction To Risk Arbitrage: Rainy Day Returns? (PDF).

In case you are wondering, risk arbitrage is not just for hedge fund managers and as mentioned in the article above, has been used by both Warren Buffett of Berkshire Hathaway (BRK-A) and his guru Benjamin Graham.

A SINLetter subscriber recently alerted me to a risk arbitrage opportunity in the all cash acquisition of St Joseph Capital Corp (SJOE) by Old National Bancorp (ONB). The acquisition price is $40 per share and SJOE currently trades at $39.43. If this acquisition were to close by the end of January as this subscriber expects it to, investors could get a return of  1.445% over a 20 day period or annualized returns of 26%. In the worst case scenario, if the acquisition were to close by the last day of the first quarter of 2007 (as stated in the press release last October), annualized returns would drop to 6.69%, which is still better than the returns from most CDs or the risk free treasury bill.

This scenario assumes that the acquisition will close and in the worst case will be completed before March 31, 2007. You can also enter your own expectations of when this acquisition will close into Grahams formula mentioned in the FocusInvestor.com article as well as this About.com article to come up with your anticipated annual returns from this risk arbitrage opportunity.

I want to thank George of Fat Pitch Financials for pointing me to several risk arbitrage resources from his article Arbitrage and Special Situations.




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Comments

  1. Stocks Guide 101
    January 18th, 2007

    Hello Asif,

    I came across to your blog while I was searching for stocks sites. I have found your blog is not only informative but also like a clear market view.

    Thank you for sharing your precious information with us.

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