The difficulty in closing funding for some recently concluded corporate takeovers has presented an arbitrage profit opportunity for investors willing to take some risk. In particular I refer to the $52 billion mega takeover of U.S. brewer Anheuser-Busch (Ticker : BUD), the company that is famous for Budweiser Beer, by Belgian brewer InBev. Both are well capitalized, large cap stocks, and both companies’ boards have approved the takeover. Yet InBev is feeling the impact of the credit squeeze on the deal financing and last week postponed its $13.4 billion rights issue to complete the takeover of Anheuser-Busch, but reiterated it still planned to close the purchase of the U.S. brewer by year-end. This uncertainty and potential that the deal could fall through caused BUD to trade significantly below the deal price of $70 and hence the arbitrage opportunity.
Arbitrage spreads, which measure the difference between the offered takeover price and the target company’s current trading price, have remained wide even on deals with clue chip names and committed funding. Historically, the wider the spread, the more investors doubt a deal will close. Arbitrage opportunities are simply short-term times to profit from the differences in the current and expected price.
InBev and Anheuser-Busch primarily sell alcoholic products that are nearly recession-proof, yet the arbitrage spread clearly shows the market things that one or more of the consortium of 19 banks financing the deal may pose risks to the deal going through. Lenders signed up for the first round of funding in August 2008, but financing costs were more than originally expected since the debt carried one of the highest interest margins ever seen on an investment-grade loan, sources previously said. In addition to the credit crunch, the strengthening dollar is increasing the cost of the deal to InBev.
However the management of both companies have reiterated that the deal will close by the end of the year despite short term challenges. The recent share price jump in BUD shows that the market is also starting to coming around that the deal will go through. Uncertainty and the possibility of other distractions like the recent court challenge by Group Modelo SA regarding buying back Anheuser-Busch stake in it, will mean there will continue to be some level of arbitrage spread, but to profit form it you need to act soon.
How to profit from the arbitrage spread
At the time of writing, the Anheuser-Busch (BUD) stock price was around $60. This is 16% below the $70 a share take over price offered by InBev. The spread was as high as 17% last week when the credit market pressure was at its most severe. To play this deal you can buy the stock and then participate in the end of year takeover process (more expensive choice). Or as I am doing buy 5 contracts (500 shares) of the $65 Dec call option, which are currently trading around $2 (Total Cost = $1000, as opposed to $30,000 to buy the same amount of shares). So if the merger goes through at its current takeover price of $70, I will sell the option near expiry (Dec 19), and stand to make a ($5 – $2)*500 = $1500 profit in less than 2 months. This is a 150% return for a $1000 outlay. I could make even more (thanks to the time value of the options) if the deal terms are agreed to before hand and the arbitrage spread decreases.
So if you believe that the deal will go through at the current offer price, there is some easy money to be made. If not, then move on to your next deal. Stifel Nicolaus analysts put a 90% probability on the deal’s completion at $70 a share; Standard & Poor’s today said it expects the deal to close. And InBev has being trying to soothe the nerves of investors in these volatile times; it obtained guaranteed financing, launched a charm offensive, and followed perfectly all the classic steps in a hostile takeover.
Mind you playing the arbitrage spread for profit does have its risks. If this buyout does come apart or the deal terms change, Anheuser-Busch stock may be back in the mid-$40′s faster than anyone can ask what happened. This will mean the call options will expire worthless and I will have lost $1000. So do your own research and understand the risks before pursuing this opportunity.
Disclosure: I own 5 contracts of the BUD Dec $65 call option as discussed in this article.