In merger and acquisitions, the spread is the difference in value between the current stock price of the target company and the current highest offer price, or value offered by an acquirer. This may be the cash offer price, or the value of acquirer stock using the exchange ratio. The full calculation of this value will include dividend payments of the targer firm and acquirer (if applicable) from now until the effective time of the merger or takeover. This date can of course be difficult to judge and is dependent on a number of factors. Merger Arbitrage Limited always includes dividends in this calculation and uses the expected completion date given by the acquirer in the original SEC filing accompanying the announcement of the deal as a guide. For our own proprietary trading, we employ a forecasted completion date calculated by our cohort of elves down in the basement to assess what dividends are likely to be paid.
To enable a more accurate comparison between arbitrage opportunities, traders can calculate an annualized spread. However, this comparison will be incomplete unless the risk, or downside of the trade is also considered. Related to this analysis is the simple spread. This is a straightforward calculation between the two prices (or values) and generally does not include dividends or make any adjustments for interest rates unless otherwise stated.
Example Spread Calculation
Although rumors had already surrounded a takeover of Fitbit (FIT), it was on November 1, 2019 that Google (GOOG, GOOGL) announced an all cash offer in a SEC filing for $7.35 per share. FIT stock closed that same day at $7.14. Incidentally, at the time of writing this is the highest it has been since the announcement. As there are no dividends, the spread was calculated as
$7.35 – $7.14 = $0.21 or
$0.21 / $7.14 = 2.91%
This figure can be annualized using the now somewhat unrealistic expected completion date of March 31, 2020. The reason for the spread, or difference is the uncertainty surrounding the deal closing as initially expected. In this case, an unexpected regulatory investigation into data privacy practices at Google increased concerns that the deal would consummate as first expected. Accordingly, the spread began to widen. Assessing these risks and making investments based on this analysis is the job of the merger arbitrageur. Merger Arbitrage Limited provides guidance and resources on these issues to assist traders and investors of all levels.
Additional Resources
See here for a full list of currently available merger arbitrage spreads. In addition, these investment opportunities are discussed in our weekly column “Merger Arbitrage Performance Review“. For valuing stock swap merger arbitrage deals see our FREE comprehensive excel based spread calculation tool.
