Wanting to invest like Warren Buffett, you learn his early investments were arbitrage. Your downloaded merger companies list should contain a profitable spread, but what is the average merger arbitrage spread? Journey on and find out what savvy investors know.
What is the Average Merger Arbitrage Spread?
The average merger arbitrage spread is a range of values from 1% to 15%. The fifteen percent is an arbitrary upper bound because this backend value can be higher depending on certain conditions.
What is the average merger arbitrage spread? The average merger arbitrage spread exists within a value range and changes with differing transaction and market conditions. The spread is determined by the probability of the transaction’s completion, which is dependent on deal structure and complexity, availability of favorable financing, the prevailing regulatory climate, legal constraints, potential divestiture mandates, and identifiable systemic and idiosyncratic risks. Let’s examine what the spread range can tell you:
Range Lower Bound (1% to 3%) – Narrow merger arbitrage spreads can be found in highly publicized, intensely competitive transactions. The profit potential is low, and the slim spread can indicate high market confidence in the merger’s consummation.
Mid-Range (3% to 8%) – Spreads in this range offer a greater profit opportunity and with this comes the market’s skepticism that the merger transaction will close.
Upper Range (8% or greater) – Merger arbitrage spreads in this range can be double-digit and usually have more challenges to overcome to reach a successful conclusion. There may be regulatory opposition to the merger due to anti-trust concerns or an uninterested target firm hostile to the acquirer’s merger overtures.
Stagnant spreads occur when the target’s stock price does not increase or converge toward the acquirer’s offer price. The market either does not believe the deal will close or they have surmised the acquirer is paying too much of the target firm. It is the existence of this price convergence or lack thereof, that highlights market sentiment toward the value acquired and deal closure probability.
What is the Spread in Merger Arbitrage?
A merger arbitrage spread is the price difference between the acquirer’s offer price per share and the target’s current stock price. The acquirer is the firm purchasing the target firm and the firm being acquired is the target company.
The acquirer’s offer price minus the target’s current share price minus any trade commissions minus any borrowing costs equals the net spread. The net spread times the number of target company shares owned is the net profit. This is the merger arbitrage profit an event-driven investor seeks to capture.
What is the average merger arbitrage spread? The average merger arbitrage spread is a value range of the share price discrepancies between an acquiring firm’s offered share price and the current share price of the firm being acquired.
What is the Sharpe ratio of Merger Arbitrage?
The Sharpe ratio is a financial metric that measures the risk-adjusted return of an investment. William F. Sharpe, the Nobel laureate economist, introduced the concept in his career-defining work titled, “Mutual Fund Performance”, circa 1966.
The formula is the average return of an investment minus the risk-free rate, usually the ten-year Treasury Bond, divided by the standard deviation of the investment’s return. The standard deviation is used as a measure of the risk associated with the investment.
The ratio assesses whether the excess returns are an adequate compensation for the associated risk. The higher the ratio, the better the risk-adjusted returns indicating more return per unit of risk.
What is the average merger arbitrage spread? The average merger arbitrage spread is a fluid acquirer/target stock price relationship whose convergence depends on transaction particulars and market conditions, which positively or adversely impact the transaction’s completion.
Read next: Do Brokers Allow Arbitrage?
