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A merger arbitrage lesson to learn: Sun Microsystems vs. IBM

April 07, 2009 | About:
The big news yesterday was the failed merger talks between Sun Microsystems and IBM. Sun Microsystems (JAVA) lost almost 23% of its value after the news hit the street. JAVA exploded on March 17 after rumors of a potential bid by IBM made Sun’s shares 79% more expensive.

The major sticking point was that Sun Micro believed IBM’s rumored offer of $9.40 to be too low. This news should be a lesson for all would be merger arbitrageurs to never initiate a position in an arb deal before the deal has been announced officially. Without a clear written intent from both companies, there is added uncertainty whether the deal would go through in order for the arbitrageur to close their position at a profit. That’s why arbitrageurs should expect higher risk adjusted returns if they waited for the official announcement of the deal before deciding whether the deal is worth participating in or not.

Another example of a badly timed merger arb play was the talks between Yahoo (YHOO) and Microsoft (MSFT) early in 2008. Back in February 2008, MSFT proposed to acquire YHOO for $31/share, which was a 62% premium to the closing price for the dot com company. After the announcement Yahoo jumped by 48% to 28.38. Check out my analysis of MSFT.

After three months of uncertainties however Microsoft decided that Yahoo (YHOO) valued itself too much and withdrew from negotiations, sending Yahoo shares down 15% for the day. Investors and institutions which bought Yahoo (YHOO) stock around $28.38 expecting to make an easy 9% gain were hugely disappointed.

As always, once the intent of BOTH companies is announced in favor of the deal and all the details have been accepted by both companies, should one consider initiating a merger arbitrage play. Otherwise, you would be speculating, which is not what Ben Graham and Warren Buffett preach as a winning investment philosophy.


Dividend Growth Investor

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