U.S. stock markets have fallen more than 10 percent in the last week on investor worries about a global economic slump, exacerbated by Standard & Poor’s downgrade late on Friday of the United States’ credit rating.
The difference between the price of agreed upon deals and their value today, or the spread, has widened during this period.
Many merger arbritrageurs, who took on bets that certain deals will get done, have taken significant losses as market uncertainty has gone against them and are moving out of risky positions, other traders said.
“There are zero arbs resharpening their pencils and adding risk anywhere,” said one arbitrageur.
That trader pointed to the violent moves in two companies that were targets of unsolicited bids: Ralcorp Holding Inc and Temple Inland Inc.
Ralcorp, which rejected a $4.9 billion bid from ConAgra Foods Inc earlier this year, remained near or above ConAgra’s $86-a-share cash bid until last week, when shares dropped to as low as $73.56 a share — a nearly 15 percent drop in market value over three days. Ralcorp’s market cap is now $4.3 billion.
Temple Inland — which has a $3.3 billion hostile bid from competitor International Paper on the table — has seen its shares drop 14 percent over the last week, cutting its market cap to $2.9 billion.
Even cash deals are not safe.
Varian Semiconductor Equipment Associates Inc agreed in May to be bought by Applied Materials for $4.9 billion, or $63 a share. But in the carnage of the last week, Varian’s shares dropped from around $61 a share to below $58 a share — around 8 percent below the offer. Varian’s market cap is now $4.5 billion.
A spread of more than 5 percent is generally thought to indicate significant risk to the deal.
Another arb said that the spreads of “anything with risk and financing is widening out more. The guys doing LBOs — if any merger agreement has any hint of a crack in it with regards to financing, those deals are really widening out.”
The precipitous drop in value could change the dynamics in contested situations.
In a battle for Southern Union Co, Williams Cos may have an advantage with its $5.52 billion cash offer over Energy Transfer Equity’s $5 billion cash and stock deal.
Williams has offered $44 per share, while the value of ETE’s offer has fallen 9 percent to $40.19 per share.
Williams may also be able to walk away.
Williams is now “in a nice position, where they don’t have any money tied up and it doesn’t appear they paid for financing commitments,” one arbitrageur said. “So they could wash their hands of the whole thing and that would be a nice ending for them too.”
All the investors and bankers spoke on the condition of anonymity because they were not approved to speak on the record.
Bankers are paying more attention to clauses in contracts that make deals harder to walk away from, one senior investment banker said.
“Things like reverse breakup fees, what type of financing papers are attached to a deal, can you sue for specific performance — all of that stuff that people probably paid less attention to in a healthier market will become much more in focus,” the banker said.
The crash could create opportunities for strategic buyers with lots of cash on their balance sheets.
A unit of Warren Buffett’s Berkshire Hathaway Inc jumped into a fight for Transatlantic Holdings Inc on Sunday, offering $3.24 billion.
The bid is higher than rival offers for Transatlantic from Allied World Assurance Company Holdings Ltd and Validus Holdings Ltd.
But it is lower than what Validus’ offer was worth when it made the bid last month, and only slightly above the Allied World deal when it was first struck in June.
“It would be a great time to make a move,” a second investment banker said, referring to cash-rich companies. “Once things stabilize a little bit to a point where they can think about doing something, it certainly creates opportunities.”
(Reporting by Michael Erman, Nadia Damouni, Megan Davies, Soyoung Kim and Paritosh Bansal in New York, Jessica Hall in Philadelphia and Svea Herbst in Boston. Editing by Robert MacMillan)