Merger Arbitrage. Kirchner Thomas

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      Chapter 4 expands the basic arbitrage by incorporating risk. Probabilities of failure and potential losses are incorporated into the return calculation to find an expected return of the arbitrage. Chapter 5 discusses different sources of risk and return in more detail, in particular the timing of mergers, leverage, and short sales.

      The difference between mergers and tender offers is not well understood by many investment professionals. The terms are often used interchangeably. Chapter 6 goes into details and should be of interest to all investors, not just those seeking to read up on merger arbitrage.

      Financing is often one of the most critical parts of an acquisition, and so Chapter 7 will look at different financing options.

      Mergers are subject to a plethora of legal requirements, and I discuss them under different angles. Readers should keep in mind that this is a financial book and not a legal textbook, so that many aspects are touched on only in a cursory manner. Boards of directors have to follow a number of procedures to ensure that a merger is fair to shareholders. This will be discussed in Chapter 8.

      Unfortunately, the law that is supposed to protect shareholders is often disregarded when managers buy the companies that they are managing as agents of their shareholders. Chapter 9 looks at management incentives for getting mergers done and how the interest of managers are often diametrically opposed to those of shareholders.

      Similar conflicts of interest between managers, acquirers, and shareholders can be found in buyouts by private equity funds, discussed in Chapter 10.

      Minority squeeze-outs present risks of their own to merger arbitrageurs, and therefore are discussed in a chapter of their own, Chapter 11.

      The government gets involved in the merger process on several levels, federal and state. Despite the obvious importance of government regulations, I have decided to relegate its discussion further to the back of the book because I believe that the motivations of the market participants – management, financiers, board members – are more relevant by far to the success of a merger than government regulations, discussed in Chapter 12. As they say: where there is a will, there is a way.

      Next, I step into a minefield by encouraging investors to seek to exercise their rights and get full value for their shares when a company is taken over. Chapter 13 describes methods that shareholders can use to that end. Too often have I seen investors resign when their company gets taken over for a lowball price. Most investors view themselves as stock pickers and will throw in the towel too early. I hope that this chapter will convince investors, maybe even some institutional investors, to fight for full value. Chapter 14 gives some practical tips on investing in merger arbitrage. In particular, readers should retain that cash holdings of event-driven investment strategies are dependent on events and not a deliberate asset allocation decision. As a result, merger arbitrageurs can have highly variable cash positions that are not an indication of the arbitrageur's view of the market.

      The last chapter contains some mathematical material. Stephen Hawking remarked in the introduction to his well-known A Brief History of Time that his publisher advised him that each formula would reduce the potential readership by half. I trust that readers of financial books can handle a few formulae.

      Acknowledgments

      I thank the editorial team at John Wiley & Sons for their support throughout the development of the book, in particular Laura Walsh, who first contacted me with the idea for this book, Emilie Herman, Meg Freeborn, and Bill Falloon as well as the reviewers who made valuable comments.

      Ron Charnock has been very supportive and encouraged me with many helpful tips. Others who have given me ideas, sometimes unwittingly, that are incorporated in the text are Geoffrey Foisie, Randy Baron, Juan Monteverde, Randall Steinmeyer, Eric Andersen, and Marc Weinberg.

      Adam Mersereau recognized the potential behind applying the newsvendor formula to the cash management problem and referred me to Warren Powell, who developed the algorithm in Chapter 14 with Juliana Nascimento.

      Ashish Tripathy worked with me on analyzing probabilities for the closing or failure of mergers.

      Finally, I thank all authors who have given me permission to reprint tables or figures from other studies.

      Part One

      The Arbitrage Process

      Chapter 1

      Introduction to Merger Arbitrage

      Arbitrage is one of the oldest forms of commercial activity. One of the earliest published definitions of the term arbitrage can be found in Wyndham Beaves's seminal Lex Mercatoria,1 first published in 1685, which trained several generations of European merchants until its last edition of 1803. One will be hard pressed to find a finance book today that has been in print for over a century. In the 1734 edition, Beaves writes about arbitrage:

      Around that time also appeared in Basel the first book dedicated to arbitrage, J. Wiertz's 1725 oeuvre Traite des Arbitrages de Change,2 which discusses various calculation methods to convert one currency into another. All of these early forms of arbitrage involved currency arbitrage. Patrick Kelly describes a typical nineteenth-century arbitrage in his 1811 book The Universal Cambist, and Commercial Instructor: Being a General Treatise on Exchange, Including the Monies, Coins, Weights and Measures of All Trading Nations and Their Colonies: with an Account of Their Banks and Paper Currencies,3 which took over from Beaves's Lex Mercatoria as the obligatory text book for merchants in the nineteenth century:

      Arbitration of Exchange

      Arbitration of Exchange is a comparison between the course of exchange of several places, in order to ascertain the most advantageous method of drawing or remitting Bills. It is distinguished into simple and compound arbitration: the former comprehends the exchanges of three places only, and the latter of more than three places.

      Simple Arbitration

      Is a comparison between the exchanges of two places with respect to a third – that is to say, it is a method of finding such a rate of exchange between two places as shall be in proportion with the rates quoted between each of them and a third place. The exchange thus determined is called the Arbitrated Price, and also Proportional Exchange.

      If, for example, the course between London and Paris be 24 Francs for £1 sterling, and between Paris and Amsterdam 54d. Flemish for 3 Francs, (that is, 36s. Flemish for 24 Francs,) the arbitrated СКАЧАТЬ