A cash deal is an offer made by an acquirer for the stock of the target company made entirely in cash. This is the simplest of all types of mergers and acquisitions payments. Cash is often sourced from existing holdings for smaller deals. A larger takeover may require additional borrowing or the use of some kind of credit facility and may be referred to as a leveraged buy out (LBO). Source of funds is an important element of merger arbitrage trading and the arbitrageur must investigate the source so as to help estimate the deal closing probability (DCP). If funding is securely in place, the DCP would be higher than otherwise.
An example of a well-known all cash deal is the takeover of Fitbit (FIT) by Google (GOOG, GOOGL). For a selection of additional cash deals traders are directed to our Merger Arbitrage Cash Deals category page.
A cash deal can be contrast with Stock Swap. This is where payment for the target’s stock is made with acquirer stock and sometimes supplemented with a cash element. However, despite the cash portion, these types of payment structure are often characterized as stock deals because they will still need to adhere to the regulatory issues associated will an all stock deal.
Cash Deal Example
On February 18, 2020, Franklin Resources announced an all cash offer of $50 a share for Legg Mason. The closing price of the stock before the announcement was $40.73. Following the announcement, the stock jumped above the offer price and traded at a premium. However, should this deal close as planned, shareholders will only receive $50 per share. This is the risk of speculating on a higher offer or a bidding war following what is perceived as an inadequate acquisition premium from the acquirer.
However, occasionally, between the deal announcement and the closing, it is at the discretion of the parties involved as to whether or not any dividend (if applicable) distribution will be made. This will be conveyed clearly to the target shareholders and it is important the trader learns of this information and incorporates it into the annualized return calculation. A significant dividend payment may be sufficient to push the current stock price above the offer price. In calculating the profitability of the investment, the trader must also take into account the interest rate level of the lifetime of the deal as this can mislead the attractiveness of the investment.
As the deal closes, the acquirer, or purchaser will buy the target shares owned by the trader leaving them with a long cash positon. If the stock is held in a brokerage account, all the trader will need to do is vote the stock when required to do so at the extraordinary general meeting. This will be done electronically. Then, once the deal closes, the brokerage account will be credited with the funds from the acquirer.
