Merger Arbitrage. Kirchner Thomas

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СКАЧАТЬ with Collars

      The CGA/B2Gold merger discussed above had a fixed exchange ratio of 0.74. This exposes both CGA and B2Gold to a certain market risk: If the value of B2Gold's stock increases significantly, then the 0.74 shares that CGA shareholders will receive for each share will also increase in value. In this case, the value of the transaction will be much higher than $4 billion. While CGA shareholders will be happy with this outcome, the investors in B2Gold will wonder whether they could have acquired CGA by issuing fewer shares and suffering less dilution. Conversely, if B2Gold's stock falls, then CGA's shareholders will receive less valuable shares for each B2Gold share. They would have been better off with a higher exchange ratio.

      For this reason, many merger agreements include provisions to fix the value of stock received by the target company's shareholders at a set dollar amount or at a fixed exchange ratio. The exchange ratio is adjusted as a function of the share price of the acquirer. Two reference prices are determined.

      Two types of collars are common:

      1. Fixed-value collars. Target shareholders will receive a set dollar value's worth of shares of the acquirer as long as the acquirer's share price is within a certain collar. This collar is buyer-friendly. The exchange ratio can change within the collar range. This type of collar is so common that the term fixed value is often dropped. References to a generic “collar” relate to fixed-value collars.

      2. Fixed-share collars. A set number of shares is given to the target shareholders as long as the acquirer's share price is within a certain range. If the acquirer's share price rises above the maximum, the exchange ratio declines. This collar is seller-friendly. The exchange ratio is fixed within the collar range.

The November 2012 acquisition of investment bank KBW, Inc., by Stifel Financial Corp. contained a fixed-value collar, shown in the press release in Exhibit 2.6.

Exhibit 2.6 Acquisition of KBW, Inc. by Stifel Financial Corp

      Stifel Financial Corp. (NYSE: SF) and KBW, Inc. (NYSE: KBW) today announced that they have entered into a definitive merger agreement to create the premier middle-market investment bank with a specialized focus on the financial services industry.

      Under the terms of the agreement, which was unanimously approved by the boards of directors of both companies, KBW shareholders will receive $17.50 per share, comprised of $10.00 per share in cash and $7.50 per share in Stifel common stock. Additionally, holders of certain restricted KBW shares, that will continue to vest post closing, will receive $17.50 in Stifel common stock. The stock component of the consideration is fixed at $7.50 per share, subject to a collar, provided that the volume weighted average closing price of Stifel common stock for the ten days prior to closing is between $29.00 and $35.00 per share. If the volume weighted average price rises above $35.00 per share, the exchange ratio will be fixed at 0.2143 shares of Stifel common stock for each share of KBW, and if it falls below $29.00 per share, the exchange ratio will be fixed at 0.2586 shares of Stifel common stock for each share of KBW.

      The transaction is valued in excess of $575 million, which includes the outstanding shares and restricted stock awards of KBW. Approximately $250 million in excess capital on KBW's balance sheet is expected to be immediately available to Stifel upon closing.

      In this acquisition, KBW shareholders will receive a package worth $17.50 as long as the share price of Stifel is between $29 and $35. In this case, they will receive $10 in cash and $7.50 worth of Stifel stock. For example, if the price of Stifel is $31, they will receive $10 plus 0.2419 shares of Stifel. The ratio of 0.2419 is calculated by dividing $7.50 by $31. If the price of Stifel stock falls below $29, then the ratio will be fixed at 0.2586, so if Stifel stock is worth only $25, then the value received by KBW shareholders will be only $16.47 ($10 cash, plus Stifel stock worth $25 × 0.2586). Below the lower collar boundary, KBW shareholders will participate in any depreciation of Stifel shares, as they would if the ratio had been fixed, and will receive less value than $17.50. Similarly, for a share price above the upper boundary of the collar, the value received will exceed $17.50. For example, for a price of Stifel shares of $40, KBW shareholders will receive a package worth $18.57 ($10 cash, plus Stifel stock worth $40 × 0.2143). Certainty as to the value exists only within the collar.

Readers are fortunate that the press release in Exhibit 2.6 is very explicit about the boundary prices of the collar. Exhibit 2.7 shows an example of a merger agreement that forces arbitrageurs to do a little extra math. An arbitrageur has to calculate the reference values for the collar from the information in the merger agreement. The value is fixed at $18.06 per share in the collar, and the exchange ratio can fluctuate between 0.4509 and 0.4650. The two reference prices are calculated as

Exhibit 2.7 Acquisition of Windrose Medical Properties by Health Care REITMerger agreement, section 2.2

      (c) Conversion of Shares. Each Share issued and outstanding immediately prior to the Merger Effective Time (other than Shares to be cancelled in accordance with Section 2.2(b)) shall be converted into a fraction of a duly authorized, validly issued, fully paid and non-assessable share of common stock, par value $1.00 per share, of Parent (a “Parent Share” and collectively, the “Parent Shares”) equal to the quotient determined by dividing $18.06 by the Parent Stock Price (as defined below) and rounding the result to the nearest 1/10,000 of a share (the “Exchange Ratio”); provided, however, that if such quotient is less than 0.4509, the Exchange Ratio will be 0.4509 and if such quotient is greater than 0.4650, the Exchange Ratio will be 0.4650. For the purposes of this Section 2.2, the term “Parent Stock Price” means the average of the volume weighted average price per Parent Share on the NYSE, as reported on Bloomberg by typing “HCN.N <EQUITY> AQR <GO>”, for ten (10) trading days, selected by lot, from among the fifteen (15) consecutive trading days ending on (and including) the date that is five trading days prior to the Effective Times.

This is an uncharacteristically narrow collar. As long as Health Care REIT's stock price remains between $38.84 and $40.05, Windrose's shareholder will receive $18.06 worth of Health Care REIT's stock. The range for this collar is less than 5 percent of the buyer's stock price. Typical are ranges of 10 or 15 percent. It can be seen from chart in Figure 2.6 that Health Care REIT was fluctuating quite wildly during the merger period and exceeded the upper limit of the collar by the time of the closing on December 20, 2006.

Figure 2.6 Fluctuation of Health Care REIT's Stock Price Prior to the Merger

      Arbitrageurs must hedge mergers with collars dynamically. If the merger is hedged with a static ratio and the stock price of the acquirer moves, the arbitrageur will incur a loss. For example, 10 days after the announcement, Stifel traded below $29 and an arbitrageur investing at that time would have hedged with a ratio of 0.2586. By January 2013 and until the closing, Stifel stock traded above $35. Therefore, at the time of the closing, the arbitrageur would have received only 0.2143 shares. The arbitrageur would have had an excess short position of 0.0443 shares. With Stifel worth $38.75 on the day of the closing of the merger, an arbitrageur would have had to purchase these extra short shares at a cost of $1.717 per share of KBW. This would have reduced the profitability of the arbitrage by about 10 percent, and led to a loss. Conversely, if an arbitrageur enters into a position when it trades at the upper bound of the collar and the stock price declines, there will be an insufficient number of shares sold short. This underhedging results in the short position not generating enough return to offset losses on the long position of the arbitrage. The correct way to hedge a collar is dynamically, in the same way that an option collar is hedged by an option market maker.

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