Question

3. Private Equity Fund has made a tender offer for LinkedIn at $50 per share. LinkedIn stock was trading at $40 per share before the tender offer. It would take 2 months to close the acquisition. LinkedIn’s stock immediately rose to $48 per share upon the tender offer announcement. Your arbitrage boutique believes the tender offer has a 90% chance of succeeding.

1. If you buy LinkedIn stock at $48 per share, what is your gain per share if the tender offer succeeds?
2. If you are wrong and the deal does not close, and the stock returns to its former trading price, how much do you lose per share?
3. What is your expected return if you buy LinkedIn stock?
4. If your hurdle rate of return is 30%, should you buy the stock? Explain.

Answer 1

a) If the tender offer succeeds, stock price will be $50 per share, resulting in a gain per share of $2 ($50 - $48) from the purchase price of $48.

b) If the deal does not close, and the stock returns to $40 per share, loss per share = $40 - $48 = -$8

c) Based on the above two scenarios, expected return = sum of (probability of scenario * expected return in scenario) = (90% * $2) + (10% * -$8) = 1.8 - 0.8 = $1 per share

This translates into a rate of return of 1 / 48 = 2.08% over 2 months, or annualized return of 13.17% (=((1+2.08%)^6)

d) As expected annualized return (13.17%) is below the hurdle rate of 30%, we should not buy the stock today.