Wednesday, April 15, 2009

Merger arbitrage

A word about merger arb. On July 10, 2008 Dow Chemical announced that it had contracted to buy Rohm & Haas for $78 a share in cash. ROH stock increased by 60% on the day of the announcement, closing at $73.62. The difference between $73.62 and $78 thereafter represented the arbitrage opportunity.

The deal offered travellers a bumpy road. In general, the risks of merger arbitrage are (a) that the deal will not happen, due to a regulatory barrier or stockholder cold feet or other cause, or (b) that the deal will eventually happen, but on terms or after a delay that will have sucked the profit opportunity out of it.

Obviously, the quicker the better for an investor going long on the target. [The other side of the classic merger arb play, especially when an exchange of shares at a fixed ratio is involved, is going short on the buyer -- but that isn't applicable to ROH].

In this matter, the merger didn't finally close until April 1, 2009. At a modified sales price of $78.97, that amounts to an annualized recovery of about 9%.

No disaster, but surely less than they had hoped for last summer.

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