The simple spread, or simple merger spread, is the percentage difference between the current target stock price and the current highest price offered by an acquirer in a takeover situation. In mergers and acquisitions there may be numerous bidders with multiple bids resulting in a bidding war, but unless specified otherwise it is the highest bid value per target share that is used in the calculation. This “simple” figure means the number is not annualized which would require additional information such as expected closing date or a forecast closing date.
The simple spread however can include dividends and/or other cash distributions that have been announced. A judgement must be made on how many dividend payments are to be received before the deal consummates. This will involve an analysis of the deal closing schedule. It is therefore common practice to specify whether any cash distributions have been included in the calculation.
A Simple Spread Example
LVMH has offered $135.00 per share for Tiffany & Co. (TIF). If the target stock is currently trading at $125.00, the simple spread calculation will be as follows
($135.00 – $125.00) / $125.00 = 8.00%
However, Tiffany currently pays a dividend of $0.585 per quarter and has stated that it will continue to do so whilst the deal is being completed. The trader needs to judge how many more dividends they think they will receive if the deal is successfully consummated. We can use the expected completion date as given in the official company filings with the SEC. Up to this date there will be two additional dividends payments. Assuming the level of the dividend remains constant, the calculation then becomes
($135.00 – $125.00 + 2 x $0.585) / $125.00 = 8.94%
When quoting the final figure, it is common practice to state how much and how many dividends are included should this be the case. In common practice few companies actually pay a dividend during the merger process. In this case, the simple spread provides a quick and simple way to analyse a spread. This helps give the trader an idea of how the spread has evolved during the offer period since the deal announcement.
More involved calculations of the annualized spread however can make comparisons between different spreads of different takeovers more accurate. However, a greater requirement of accuracy will be required for the completion date.
Additional Resources
Merger Arbitrage Limited produces a frequently updated list of current merger arbitrage spreads showing the simple spread and annualized return. Real time significant changes in the level of these risk arbitrage spreads indicating potential trading opportunities are announced via our Twitter feed. In conjunction with this, a weekly commentary is also available making frequent references to simple spreads of various merger arbitrage stocks. There is also a news service related to the stocks.
