The floor price is the share price value to which a stock will return to following the cancellation of a merger or acquisition. This is a dynamic value. As time goes by, this price will evolve as new information concerning the company’s success (as what would have been a stand alone company if the deal was never proposed) is consumed by the market. In this regard, macro economic factors (beta) in addition to stock specific factors (excluding the acquisition proposal) must also be taken into account. There are various methods by which this floor price can be calculated, many of which involve a proprietary formula. However, some are discussed at length throughout this website.
Floor Price Example
Traders and arbitrageurs should pay particular attention to earnings reports and other company specific information that would have a significant effect on the stock price were this not a takeover situation. The importance of information that would normally move the target stock price significantly, but which may have a muted effect during a takeover situation is often overlooked and undervalued by traders and investors. Should a company issue a series of below forecast earnings, it would significantly increase the risk associated with investing in merger stocks and trading the merger arbitrage spread. This is because the potential downside would have greatly increased as the floor price will have declined whilst the upside remained the same. As a result of a declining floor price, the merger spread will increase whilst maintaining a relatively stable deal closing probability (DCP).
An example of this is Red Robin Gourmet Burgers (RRGB). Although this is a hostile bid, since the original takeover proposal was announced the company has reported a series of lackluster results. Often below analysts expectations in terms of both revenue and earnings. Therefore, should the deal fail to consummate, it is reasonable to expect the stock to drop far below where it was trading when the deal was first announced. Even for adjusting for any overall improvement in the restaurant sector whilst this deal progresses the floor price would still be expected to decline heavily. NOTE: this analysis DOES NOT take into account the effect of the COVID-19 pandemic has had on the stock market and the economy and specifically the devastating effect on the hospitality industry.
