announcement is made prior to the drafting of the definitive agreement. In
such cases, the announcement would be construed as an agreement in prin-
ciple. Subsequently, a registration statement is filed with the Securities and
Exchange Commission (SEC). The SEC looks at the statement in the context
of various legal statutes causing rounds of amendments based on its com-
ments. Subsequently, the registration statement is declared “effective,” and
the document is mailed to the shareholders for their approval. The share-
holders vote then takes place and is followed by deal closing.
An exchange offer is somewhat of a hybrid between a merger and a ten-
der offer. It is an unsolicited bid like in the case of a tender offer. However,
unlike the tender offer, the bid is made in terms of the acquirer’s stock as op-
posed to cash. Thus, in this aspect, it is similar to mergers. The formal ex-
change offer is made though advertisements in the Wall Street Journaland
local newspapers. Since this involves the issuance of new stock, it goes
through the same registration process with the SEC as is required for merg-
ers. In this case, however, the completion of the transaction does not require
a shareholders’ vote.
Also note that mergers and exchange offers both have quite a bit in com-
mon with regards to their transaction terms. This is the topic of discussion
in the next section on transaction terms and unless specifically mentioned,
our discussions apply to both of them.
Transaction Terms
Transaction terms, in the case of mergers, are usually contained in the proxy
statement that is part of the merger agreement document. In the case of an
exchange offer, the transaction terms are available in the exchange offer
advertisement.
It is useful at this point to specify the convention used in the ensuing dis-
cussion. The two companies involved in the transaction will be referred to as
the bidder (B) and target (T). In all of our references involving exchange of
shares, the convention we will follow is as follows. The shares of the target
firm are given up and exchanged for shares of the bidder firm. With that, we
are now ready to discuss transaction terms.
The valuation of the target firm during the due diligence process is typ-
ically in dollar terms, leading to a specific dollar amount for the target stock.
While this dollar amount may be agreeable to both the parties involved in
a transaction, note that it is a little hard to pay the exact specific dollar
amount. This is because the payment for the target stock is made in terms of
the bidder stock, and the price of the bidder stock varies on a day-to-day
basis. Therefore, the key challenge in structuring the transaction is in find-
ing an approach to pay a specific dollar amount for the target stock that is
equitable to both the bidder and target companies.
142 RISK ARBITRAGE PAIRS