Valuation for Mergers, Buyouts, and Restructuring, Second Edition

Chapter 11

Special Offer Structures: Price Guarantees and Collars

11.1 SPECIAL OFFER STRUCTURES

The value of the consideration in a share-exchange offer depends on the market perception about the stock price of the acquirer and on the probability attached to the consummation of the merger. Shareholders can diversify away the specific risk of the buyer's stock, but value depends on the expected gains from the merger, which investors estimate on the basis of management declarations, their track record and credibility, and general economic and competitor analyses. In addition, investors have to estimate the probability of the merger going through and the effect on the possible synergies of delays because of regulatory review.

11.1.1 Risk Arbitrage

The uncertainty about the value of the offer attracts the activity of arbitrageurs. They are specialists in gathering and analyzing information pertaining to the deal and estimating the probability of its consummation. Their goal is to profit from the spread between the offer “see-through” price and the market price of the target. In doing so, they provide liquidity to the market by standing ready to buy the stock of the target from investors unwilling to bear the risk that the merger may not take effect. A typical arbitrage consists in buying the target and shorting the acquirer in proportion to the exchange ratio of the offer. In this way, the arbitrageur hedges the risk of market fluctuations and guarantees the spread under any market ...