Investors expecting Bayer to counter bought shares for as much as 6% higher than Reckitt Benckiser’s very generous offer. Two trading days after Reckitt’s offer, Bayer dropped out of the competition; the bidding war was over before it began.
If you’re going to play the M&A arbitrage game, you’d better be operating on more than a hunch, because the pros will take your action every day of the week.
Do the Math
MarketWatch contributor Andy Hicks, a buy-side equity trader in San Francisco, discussed using merger arbitrage to generate excess returns on your portfolio’s cash. Hicks reckons that if you select cash-only deals that represent less than 25% of the acquirer’s market cap and will close within six months, you might be able to squeeze out an additional 31 basis points of yield over a six-month Treasury bill. Hicks uses three M&A opportunities:
- National Oilwell Varco (NYSE:NOV) and Robbins & Myers (NYSE:RBN)
- IBM (NYSE:IBM) and Kenexa (NYSE:KNXA)
- Wellpoint (NYSE:WLP) and Amerigroup (NYSE:AGP)
He ends up assigning 30% of an imaginary $25,000 in the first deal, 50% in the second, and 20% in the third and final deal. All told, you’d generate $54.50 in income over the six-month arbitrage compared with $16.25 for the T-bill.
That sounds great … except the fact that deals don’t always take place.
In the three examples above, only the IBM deal has been completed, and National-Oilwell Varco’s purchase of Robbins & Myers has been delayed into 2013 because of additional information requested by Canada’s Competition Bureau and the U.S. Department of Justice’s ongoing review. In this instance, the six months is entirely necessary.
What happens if the deal falls through?
One can never know for sure, but Robbins & Myers traded for $46.80 the day before the announcement. It’s entirely possible that the stampede to exit would send its shares back to where they came from. How fast you’re able to exit determines how bad your losses will be. In Hicks’ example, you’d have bought at $59.65 per share, a 35-cent spread between your price and the buyout price. If it goes all the way back to $46.80, you’ve lost $1,600 instead of the projected gain of $17.50 (after commissions).
The moral of the story in all three of these examples is that merger arbitrage is best played only by the professionals. If you’re parking money for six months, the last thing you should be doing is betting on the takeover spread.
If you want to blow $1,600, go spend it at JCPenney (NYSE:JCP). At least then somebody might get a job out of it.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.