How wide can deal-spreads stretch before they break?

October 22, 2008

Arbitrage spreads on mergers have narrowed a bit from their widest levels two weeks ago, but still remain wide on a historical basis, according to Andy Baker, special situations trading strategist for Jefferies & Co Inc. 

Spreads measure the difference between the offered takeover price and the target company’s current trading price. Historically, the wider the spread, the more investors doubt a deal will close. 

Spreads are about three times wider than they were prior to the bankruptcy of Lehman Brothers, Baker said, with raw spreads currently averaging just under 10 percent.

Average spreads on strategic stock deals have improved in the past week, tightening to 8.9 percent at last night’s close, down from 11.5 percent a week ago. Strategic cash deals tightened somewhat to 6.3 percent, versus 6.9 percent a week.

Still, the spread for the InBev and Anheuser-Busch deal stood at 11.6 percent on Wedneday, while  Bank of America Corp’s planned purchase of Merrill Lynch had a spread of 10.6 percent. The spread of Cleveland Cliff’s planned purchase of Alpha Natural Resources stood at 35.7 percent, according to Reuters data.

Leverage buyouts continue to have among the widest spreads, reflecting the greater uncertainty that those deals will close amid the weak credit market and global financial crisis, Baker said. The spread on the $32.5 billion LBO of BCE Inc, the parent of Canada’s largest telephone company, stood at 18.9 percent, according to Reuters data. 

Some spreads have been stretched to the breaking point.

On Wednesday, Samsung Electronics Co Ltd, the world’s top memory chip maker, withdrew a $5.9 billion unsolicited bid for flash memory card maker SanDisk, citing the U.S. company’s deepening losses and uncertain outlook.

Investors had already been doubtful of a deal between Samsung and SanDisk, given that the spread between Samsung’s offer price and SanDisk’s trading price was 80 percent, according to Reuters data.

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