Question

Solve the following and show steps please:

On February 1^st, 2016 Heinz Baking Company (HNZ) announced that they were going to be acquired by Best Foods, Inc. (BFI) in a stock swap transaction. Specifically, each share of Heinz Baking Company would be exchanged for 1.62 shares in Best Foods. At the close of trading on the announcement date, HNZ was trading at $37.62 per share, and BFI was priced at $24.48 per share. Best Foods stock does not currently pay a dividend.

a- At announcement, what was the arbitrage spread? (5.42%)

b- If you want to undertake the typical M&A arbitrage strategy and buy a parcel of 3 million shares in HNZ, what trade would you make in the stock of BFI? (Short sell 4.86 million shares in BFI)

c- What would your dollar profit on the announcement date be from the trade described in b. above? ($6,112,800)

d- Sixty days after announcement, the stock price of BFI has risen 4%, but the price of stock in HNZ is unchanged from where it closed at announcement. What is the arbitrage spread at this time? (9.64%)

Answer 1

a) Arbitrage spread = [(Shares of Best Food stocks to be received in exchange * Price of Best Food stock)-(Price of Heinz Backing Stock)] / Price of Heinz Backing Stock

=> [(1.62*$24.48)-$37.62] / $37.62 = 0.0542 or 5.42%

b) Since you are buying HNZ’s shares, you will short shares of BFI to gain from this arbitrage strategy.

Number of shares to be shorted = 3,000,000 x 1.62 = 4,860,000

c) The 3 million HNZ shares purchased will be exchanged for 4.86 million share of BFI, which will be used to make the delivery of the shares shorted. The profit from this trade is calculated below:

Amount received from shorting shares of BFI = 4,860,000 x $24.48 = $118,972,800

Amount paid to buy 3 million shares of HNZ = 3,000,000 x $37.62 = 112,860,000

Profit from the trade = $118,972,800 - 112,860,000 = $6,112,800

d)Stock price of BFI after 6 days = $24.48*(1+0.04) = $25.4592

Arbitrage spread = [(Shares of Best Food stocks to be received in exchange * Price of Best Food stock)-(Price of Heinz Backing Stock)] / Price of Heinz Backing Stock

=> [(1.62*$ 25.4592)-$37.62] / $37.62 = 0.096329187 or 9.64%