Tip #2002-01: Merger Arbitrage Tick by Tick
A week does not go by when there is not at least one announcement of one company merging or being taken
over by another. Many of these mergers create the opportunity for a strategy that is used by sophisticated
investors, such as hedge funds, called merger arbitrage.
Merger arbitrage is a market neutral strategy and reduces market risk. It is designed to ensure profits
regardless the direction of the market. After a company announces the intent to acquire another, the stock
price of the target company predictably goes up, although not to the full merged value price. You can easily
calculate the merged value price by reviewing the terms of the merger. Because of the risk of the deal not
closing or happening, the target company's stock will sell at discount. This discount or spread is calculated
by subtracting the target company's current price from its merged value price.
The merger arbitrageur seeks to lock in this spread. When the offer is a cash offer, the arbitrageur merely
has to buy the stock of the target in order to do this. However, when the offer is for an exchange of securities,
the merger arbitrageur must also hedge against the possibility of the acquirer's stock falling. He does this
by selling the acquirer's stock short as well as buying the target company's stock. Once the merger is consummated,
the arbitrageur converts the shares of the target company into the shares of the acquiring company. The shares
of the acquiring company are then used to close out the short position and the spread becomes the profit.
Use Excel to Calculate and Monitor a Merger Spread
Excel provides an excellent vehicle to monitor a merger arbitrage. You can easily enter the terms of the merger,
perform the calculations using the real-time prices of the securities involved, and determine the spread.
We have created a merger arbitrage model, which makes it easy to enter the terms of the merger and calculate the
arbitrage spread using real time prices. Our model goes a step further by collecting the price and spread data
tick by tick and displaying the spread on a chart. We have added a macro that uses the OnData method to copy
the prices and trade size of the buying and target companies along with the spread to a table. The spread data
is plotted on an adjoining chart. The data is added to the table when either the price of the buying or the
target company is updated. The spread plot on the chart becomes a valuable decision making tool. It allows
you to see if the spread is increasing or decreasing and also to see the boundaries of the spread as the two
stocks trade. Download a sample spreadsheet.
We used our model to monitor the arbitrage spread created by a recently announced merger between Amgen Corp. and
Immunex Corp. Amgen announced it would buy Immunex for a price, which includes .44 of share of Amgen plus $4.50
in cash. To calculate the merged value, you need to multiply the real-time price of Amgen by .44 and add 4.50.
When we did the calculation, we got a merged value of $30. However the real-time price of Immunex was 28.25.
The arbitrage spread is (30 - 28.25) or 1.75. As the price of the acquiring and the target companies fluctuates
the spread will increase or decrease. Our model lets you monitor this spread tick by tick.
You can use this model to monitor any merger arbitrage spread by simply entering the instrument codes for the
acquiring and target companies along with terms of the merger into the proper cells on the worksheet and clicking
on the Reset button. We found a web site, which keeps tabs on recently announced mergers and provides you with a
summary of the terms. http://www.investhelp.com/mergers.phtml
Using the Model
If you are a Bloomberg, Bridge or Reuters subscriber:
- Select the data vendor from the Source drop-down to have the correct DDE formulas entered on the worksheet.
- Enter the correct instrument codes for the data vendor you selected.
- Enter the terms of the merger to calculate the merged value and the spread.
- Click on the Reset button to clear the existing data and update the real-time data formulas.
- Click on the Turn Collection On button to begin collecting data and plotting the spread.
Contact us if you would like to employ our services to help you enhance
this model or help you design financial models or customized applications using Bloomberg, Bridge, ILX, Factset
or Reuters data.
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