Merger Arbitrage Spread Calculator – Free Calculation Tool

When an acquiring company chooses stock as a form of financing calculating the spread becomes slightly more complex than for a simple all cash offer. If dividends are involved and payable on BOTH the acquirer and target stock, the difficulty level rises again.

A large takeover (relative to the size of the acquirer) generally requires at least part payment in acquirer stock due to the difficulty in raising such a large amount of cash and the increased risk that additional debt burden brings. A stock deal reduces this burden but also dilutes existing shareholders control. A cash and stock offer will maintain the existing capital structure ratio and may negate the drawbacks of either singular option. Whether or not the deal is immediately earnings accretive is a factor specific to the deal. Once stock financing is agreed, the exchange ratio of acquirer shares for each target share needs to be calculated. The acquirer and its advisors amongst other things will to take into account the control premium offered to existing target shareholders to entice them to vote favorably on the deal at the extraordinary general meeting and the subsequent effect on the acquirer stock price following the announcement. A less than positive response from the market possibly due to perceived overpayment or unattainable synergies will depress the acquirer stock price. This makes the deal less valuable to the target shareholders and reduces the acquisition premium available to arbitrageurs.

The choice of payment in stock complicates the spread calculation because of the ratio of shares offered. The timing and payment of dividends further compounds this complication. Interest rates and the time value of money may have a large effect on these values. The most complicated version of this payment method is a “collar”. This is where the ratio of acquirer shares offered fluctuates depending on the value of acquirer stock at a predetermined time usually just prior to the completion of the deal. Due to the complexities involved in calculating this type of merger spread, we will subsequently be producing a separate accompanying article to deal with this topic.

Using the Model

Let us start building our model and value this spread. Throughout this guide, cells requiring user input are shaded light yellow. Don not worry if you make a mistake, a helpful pop-up message will appear to let you know what happened. Just press “esc” and continue with the correct data entry.

The green section “Offer Details” contains information specific to the deal as well as interest rates. This data will be available in the merger announcement usually given as a press release from Business Wire or a similar agency such as Cision PR Newswire. In addition, Merger Arbitrage Limited also publishes vital deal information for traders via the Merger Arbitrage Stocks page listings. These deal details also available using the dropdown menu at the top of the page. The interest rate should be commensurate with the time expected for the deal to complete.

In the blue “Acquirer” section we will add the current acquirer stock price but also any dividend information. Traders can enter up to four dividends, usually representing one year. Dividend data is easily obtainable from data providers such as Yahoo or your broker. The grey fields to the right of the dividend information calculate the present value of the dividend payments that fall within the expected timeframe of the deal. That is to say, dividends payable in the future have a discounted value in the present. This adjustment has NOT been made for the stock transactions because of individual rules regarding the payment of interest on short stock positions in brokerage accounts. The trader then repeats this process for the “Target” section highlighted in orange. If there are no dividends forecast, the trader can leave these fields blank.

The purple section, “Offer Analysis” displays a brief analysis of the return available by initiating a position in the spread. This figure includes dividend payments and is the present value of the spread adjusted for interest rates. It includes an annualized figure based on the expected date of deal consummation entered above.

Merger Arbitrage Spread Calculator – A Worked Example

On July 20, 2020, Chevron Corporation (CVX) and Noble Energy (NBL) announced a merger in an all-stock deal where NBL shareholders will receive 0.1191 shares of CVX for each NBL share they own. The expected deal closing schedule is given as Q4 2020 so we will use a singular closing date of December 31 2020. The stock price at market close for CVX following the announcement of the deal, was $84.06 and for NBL was $10.16. The forecast dividend payment information which was supplied by Interactive Brokers is listed in the following table.