Merger Arbitrage, 2nd Edition

Chapter 7Financing

The most critical aspect an arbitrageur faces in assessing the probability of whether a merger will go through is the question of financing. This is primarily a concern for cash deals or mixed cash and stock deals. As soon as a deal has a cash component, the source of the funding becomes a potential source of trouble.

In a stock-for-stock merger, financing can also be a problem. This is less obvious, because this detail is buried deep inside the covenants for the target's bonds or loans. Target companies that have debt are often required by covenants in the loan or bond documentation to redeem their debt if a merger happens. These clauses are called change-of-control covenants. If a target company has large amounts of debt outstanding, it might be difficult for a buyer to redeem the outstanding debt. This is especially true if the buyer is not very strong financially.

Merely from a net return point of view, some of the transactions least attractive for arbitrageurs are the purchases of small-cap firms by large corporations. In these cases, the buyer can often pay for the acquisition out of its cash on the balance sheet. The low risk is obvious to all market participants, and the spread reflects the low risk very quickly. The acquisition of enzyme maker Verenium Corporation by BASF SE is a good example. The tender offer was announced on September 20, 2013, with an anticipated closing “in the fourth quarter of 2013.” The transaction had an equity value of only ...