Merger Arbitrage, 2nd Edition

Chapter 2The Mechanics of Merger Arbitrage

This chapter discusses the first three types of merger consideration and how arbitrageurs will set up an arbitrage trade and profit from it:

• Cash mergers
• Stock-for-stock mergers
• Mixed stock and cash mergers

Cash Mergers

The simplest form of merger is a cash merger. It is a transaction in which a buyer proposes to acquire the shares of a target firm for a cash payment.

We will look at a practical example to illustrate the analysis. An announcement for this type of merger is shown in Exhibit 2.1, which is the press release announcing the purchase of Autonomy Corporation, a U.K.-based infrastructure software firm, by Hewlett-Packard Co. It is typical of announcement of cash mergers.

The terminology used in mergers is quite straightforward: A buyer, HP in this case, proposes to acquire a target, Autonomy here, for a consideration of £25.50 per share. The difference between the consideration and the current stock price is called the spread. When the stock price is less than the merger consideration, the spread will be positive. Sometimes the stock price will rise above the merger consideration, and the spread can become negative. This happens occasionally when there is speculation that another buyer may enter the scene and pay a higher price.

In a cash merger, the buyer of the company will cash out the existing shareholders through a cash payment, in this case £25.50 per share. An arbitrageur will profit by acquiring the shares below ...