id="x_10_i137">In the former case, every shareholder of the target company is treated equally. Exhibit 2.4 shows the announcement of the merger of Alterra Capital Holdings Ltd. with Markel Corp, announced in December 2012. This merger was mentioned briefly earlier to illustrate the effect that arbitrage-related short selling can have on a company's stock price immediately following the announcement of a merger.
RICHMOND, Va. & HAMILTON, Bermuda–(BUSINESS WIRE)–
Markel Corporation (“Markel”) (MKL) and Alterra Capital Holdings Limited (“Alterra”) (NASDAQ: ALTE; BSX: ALTE.BH) announced today that their respective boards of directors have each unanimously approved a definitive merger agreement. Under the terms of the agreement, the aggregate consideration for Alterra is approximately $3.13 billion, based on a closing price of $486.05 for Markel common stock on December 18, 2012.
At closing, each Alterra common share will be converted into the right to receive 0.04315 Markel common shares (with cash paid for fractional shares) plus a cash payment of $10. Following the merger, Markel's existing shareholders will own approximately 69 % of the combined company on a fully diluted basis, with Alterra's shareholders owning approximately 31 %. Completion of the transaction is contingent upon customary closing conditions, including shareholder and regulatory approvals, and it is expected to close in the first half of 2013.
Alterra's shareholders will receive $10 plus 0.04315 share of Markel. Alterra's shares traded on December 19 at a VWAP of $28.58, whereas those of Markel traded at a VWAP of $444.97. An arbitrageur entering a position at these prices would make a gross return of 2.17 percent:
2.9
where
This gross return should be annualized by one of the methods explained earlier. An arbitrageur would also have to factor in the receipt of at least one additional dividend of $0.16 / share, which, based on Alterra's dividend history, would be paid in the middle of February 2013. A second dividend may be paid in the middle of May, if the merger has not closed by then.
A different incarnation of mixed cash/stock transactions does not specify a set dollar amount to be received per share but instead sets a fraction of the total consideration that will be paid in cash. Frequently used ratios are 50/50 cash/stock, 40/60, or 20/80.
The acquisition by Vulcan Materials Company of Sunoco Inc. by Energy Transfer Partners, LP had the frequently used ratio of 50 percent cash and 50 percent stock. The press release is shown in Exhibit 2.5.
Exhibit 2.5 Acquisition of Sunoco Inc. by Energy Transfer Partners, LP
DALLAS & PHILADELPHIA–(BUSINESS WIRE)–Apr. 30, 2012–Energy Transfer Partners, L.P. (NYSE: ETP) and Sunoco, Inc. (NYSE: SUN) today announced that they have entered into a definitive merger agreement whereby ETP will acquire Sunoco in a unit and cash transaction valued at $50.13 per share, or a total consideration of approximately $5.3 billion, based on ETP's closing price on April 27, 2012. This combination will create one of the largest and most diversified energy partnerships in the country by expanding ETP's geographic footprint and strengthening its presence in the transportation, terminaling and logistics of crude oil, NGLs and refined products.
The merger consideration, which consists of $25 in cash and 0.5245 of an ETP common unit, or approximately 50 percent cash and 50 percent ETP common units, represents a 29 percent premium to the 20-day average closing price of Sunoco shares as of April 27, 2012.
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Other Transaction Details
Under the terms of the merger agreement, which has been unanimously approved by the boards of directors of both companies, Sunoco shareholders can elect to receive, for each Sunoco common share they own, either $50.00 in cash, 1.0490 ETP common units, or a combination of $25.00 in cash and 0.5245 ETP common units. The aggregate cash paid and common units issued will be capped so that the cash and common units will each represent 50 percent of the aggregate consideration. The cash elections and common unit elections will be subject to proration to satisfy this cap. Upon closing, Sunoco shareholders are expected to own approximately 20 percent of ETP common units. In addition, $965 million of Sunoco's existing notes will remain outstanding.
Mixed transactions with election rights can be difficult to calculate because they require some guesswork. Arbitrageurs are used to making assumptions, as we have seen in the estimation of closing dates and now again when dealing with cash/stock proration ratios. Shareholders can choose to receive either cash or stock. Arbitrageurs and some shareholders will pick the option that is worth the most. In this transaction, if the value of Energy Transfer Partners shares to be received is above $50.00 at the time of the merger, profit-maximizing shareholders will want to receive shares. If the value of these shares is less than $50, shareholders will prefer $50 in cash instead of the less valuable shares. In either case, no shareholder will accept a blend of shares and stock. The buyer would either have to pay all stock or all cash, which is not what it intended to do. For this reason, these transactions have a proration provision, so that the buyer of the firm can make the blended cash/stock payment of 50 percent stock and 50 percent cash. However, not all shareholders will seek to be paid in cash when the shares are below $50. Some shareholders fail to make a selection and will be allocated the less valuable consideration by default. Many long-term shareholders will select shares even when the cash payment is more valuable because they intend to continue to hold the shares. Strategic investors or managers will hold on to their shares. Some asset allocators may find it easier to roll their shares into the buyer's stock than reinvest themselves. Finally, the most important group selecting stock rather than cash are long-term holders who have significant appreciation in their holdings of target stock. They would be faced with an immediate tax bill if they realized a gain in the merger. By selecting stock, they can defer realization of a taxable gain into the future. Because all of these investors have a preference for stock even if the cash component is worth more at the time of the merger, slightly more cash will be paid to shareholders who select cash than if proration were applied at the stated ratio.
In the case of Sunoco, 73.92 percent of shareholders elected to receive cash, 4.25 percent elected all stock, 2.61 percent requested to receive the 50/50 proration, and the remaining 19.22 percent did not make a selection. Shareholders who did not make a selection also received the 50/50 mix. Out of luck were shareholders who elected to receive all cash: Due to proration, they received $26.47 in cash and 0.49373 shares of Energy Transfer Partners. This shows that aiming for one of the extremes – all cash or all stock – can be a risky undertaking. An arbitrageur who hoped for an all-cash allocation would have ended up with almost half of the position exposed to the market – not quite an arbitrage. Most of the time, it is optimal to target the prorated allocation. With some experience and a study of the shareholder base, it is possible to make a rough estimate of the final proration.
Arbitrageurs must use experience and guesswork to determine the ratio that is most likely to apply. In the next discussion, it is assumed for simplicity that the ratio of cash/stock that the arbitrageur will receive is that of the stated proration factor.
To calculate the gross return,
2.10
where
This gross return can be annualized by analogy with the previous
