The MA Collar Handbook
The MA Collar Handbook
The MA Collar Handbook
Gerald Adolph
Justin Pettit
The M&A
Collar Handbook
How to Manage
Equity Risk
CONTACT INFORMATION
New York
Gerald Adolph
Senior Partner
212-551-6464
[email protected]
Justin Pettit
Partner
212-551-6309
[email protected]
60
30%
50
25%
40
20%
30
15%
20
10%
10
5%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Number of Deals
Value Collar Deals/Value All Deals (Percent)
MSCi World Volatility (Percent)
1 As per Securites Data Company data. Worldwide completed mergers and acquisitions where value of the target, including net debt, was greater than $100 million.
0%
Exhibit 2
Consideration as a Function of Changes in Bidder Share Price
(a) Cash Offer
60
50
40
30
20
10
0
Fixed-Price Offer
10
0
10
20
30
40
50
60
10
20
30
40
50
60
2 Stock consideration is often denoted in shares of the bidder, but really represents shares of the combined firm.
3 Micah S. Officer, Collars and Renegotiation in Mergers and Acquisitions, The Journal of Finance, December 2004. The author suggests Travoltas and Egyptians as alternative names for
fixed-price and fixed-exchange collars respectively due to the resemblance of the former to a popular dance posture of the 1970s and the latter to hieroglyphic depictions of human figures.
Exhibit 3
Fixed-Price and Fixed Exchange Ratio Collars
(a) Fixed-Price Collar (Travolta)
Region 1
Region 2
Region 3
50
60
40
30
20
10
0
10
20
30
40
50
Region 2
Region 3
40
30
20
10
0
60
Region 1
50
10
20
30
40
50
60
Exhibit 4
Fixed Exchange Ratio Collar Illustration
100%
75%
50%
25%
0%
-25%
Bidder Benefits
-50%
-75%
-100%
-150%
-125%
-100%
-75%
-50%
-25%
0%
25%
50%
75%
100%
125%
150%
4 In a study of 632 bids over six years, collar boundaries were explicitly modeled as walk-away trigger points. Kathleen P. Fuller, Why Some Firms Use Collar Offers in Mergers, The Financial
Review, February 2003.
(b) Verizon
$40
Value to MCI at Close (Dollar/Share)
$40
$30.00
$30
$20
$10
(as of 4/21/05)
$0
$0
$1
$2
$3
$4
$5
$30
$26.00
$20
$10
$34.97
(as of 5/2/05)
$0
$6
$0
$10
$20
$30
$40
$50
$60
Collars played a crucial role in the negotiation process, not only shaping the risk and economics of the
transaction, but also signaling and shaping the perspectives of the parties involved.
5 The deal was scuttled in July 2000 when the Department of Justice filed suit to block the deal.
6 Qwest SEC Filing Form 8-K, 2/16/2005.
7 Qwest company press release, February 24, 2005.
8 SEC filings show Qwest also included a $16.00 per share cash payment, bringing the headline value of the deal to $30 per share, or $9.75 billion. Verizon proposed a cash payment of $5.60
per share, bringing the headline value of its proposal to $26 per share, or $8.45 billion.
Consideration
Consideration includes both the amount and the
form of the deal. Most research indicates that cash
consideration outperforms stock deals in postacquisition stock performance. The rationale generally
cited includes:
n
Exhibit 6
Implications of Consideration
100% Cash
(Fixed Price)
100% Stock
(Fixed Ownership)
Form of Consideration
Strong
Signal Strength
Weak
High Impact
Liquidity
Low Impact
Low Impact
Dilution
High Impact
Relative Risk
Less Favorable
Tax Considerations
Less Favorable
9 Including a collar in a bid has been shown to decrease the incidence of renegotiation by 34 percentage points from a base predicted probability of 5 percent in this study of 1,233 deals over
nine years. Micah S. Officer, Collars and Renegotiation in Mergers and Acquisitions, The Journal of Finance, December 2004.
10 Excess volume for collared deals was found to be only 146 percenta full 53 percentage points less than the 199 percent excess volume observed for uncollared transactions. Keith M. Moore,
Gene C. Lai, and Zhiyi Song, A Microstructure Examination of the Effect of Risk Arbitrage on the Trading in Acquiring Company Shares in Stock Mergers, Financial Management Association
International Working Paper, 2005.
11 Joel F. Houston and Michael D. Ryngaert, Equity Issuance and Adverse Selection: A Direct Test Using Conditional Stock Offers, The Journal of Finance, March 1997. In the first study of its
kind, the authors develop a novel metric to estimate the elasticity of a targets compensation with respect to a bidders stock price and they use this framework to analyze 209 traditional and
collared bank merger announcements between 1985 and 1992.
Exhibit 7
Collar Checklist
Size
Correlation
Regulation
Bidding
Environment
Taxes
Time Frame
Domicile
Cross-currency transaction?
Risk Aversion
12 Enrique R. Arzac, Valuation for Mergers, Buyouts, and Restructuring. John Wiley and Sons, 2005.
13 A comprehensive review of 2,130 deals announced between 1994 and 2000 finds considerable downward price pressure, and notes that, for arbitrageurs, collared offers require more short
selling at announcement than does a straight fixed-price offer and less short selling than does a straight fixed exchange ratio offer. Collared offers fall somewhere between. Mark L. Mitchell,
Todd C. Pulvino, and Erik Stafford, Price Pressure Around Mergers, Harvard NOM Working Paper, May 2002.
14 Micah S. Officer, Collars and Renegotiation in Mergers and Acquisitions, The Journal of Finance, December 2004. The author uses the elasticity framework developed by Houston and Ryngaert
to explore the motivations and effects of using collar structures in mergers.
15 Audra L. Boone and J. Harold Mulherin, Do Takeover Auctions Induce a Winners Curse? Financial Economics Institute Working Paper, July 2004. Deals were considered auctions when the
selling firm contacted multiple potential buyers and signed confidentiality agreements with multiple bidders.
16 The higher the volatility of the bidders share price, and the longer the time to closing, the more the distributions of outcomes from collared bids and no-collar bids resemble each other. In other
words, the more volatility accumulates over time, the more bidder share prices can be observed outside the collar bounds, thereby reducing the effectiveness of the protection.
Exhibit 8
Bidder and Target Natural Preferences
Bidder
Target
Fixed-Price Collar
Preferred When:
Bidder
Target
17 Micah S. Officer, The Market Pricing of Implicit Options in Merger Collars, The Journal of Business, January 2006.
18 Kathleen P. Fuller, Why Some Firms Use Collar Offers in Mergers, The Financial Review, February 2003.
19 Stock prices of bidder and target simulated via 5,000 independent paths over a one-year period after the theoretical announcement date. Closing assumed to occur, with 100 percent
certainty, nine months from announcement. Annual volatility of stock prices assumed to be 15 percent and 20 percent, respectively, for bidder and target, with the correlation of returns
equal to 45 percent.
Exhibit 9
Frequency
20 Ben Branch and Jia Wang, Risk Arbitrage for Stock Swap Offers with Collars, Financial Management Association International Working Paper, January 2005. The authors study 150 fixed-price
collared transactions.
21 Keith M. Moore, Gene C. Lai, and Zhiyi Song, A Microstructure Examination of the Effect of Risk Arbitrage on the Trading in Acquiring Company Shares in Stock Mergers, Financial Management
Association International Working Paper, 2005.
22 Kathleen P. Fuller, Why Some Firms Use Collar Offers in Mergers, The Financial Review, February 2003.
23 Micah S. Officer, The Market Pricing of Implicit Options in Merger Collars, The Journal of Business, January 2006.
24 Enrique R. Arzac, Valuation for Mergers, Buyouts, and Restructuring. John Wiley & Sons, 2005.
10
Issuer
Forward Contract
Stock
Bank
Stock
Stock Lender
Cash
Cash
Investor
Source: Booz Allen Hamilton
By executing the primary forward, the company has 1) locked in its stock price, 2) delayed issuance of
stock and hence dilution until the acquisition is consummated, and 3) preserved the flexibility to change
the maturity date of the primary forward if the merger closing date changes. In the event the merger does
not happen, the company may net cash or net share settle the contract and avoid issuing unnecessary
equity capital.
Since the first primary forward issued by Oracle Corporation in 1998, 14 transactions have been executed,
with 8 in the context of an M&A deal. Transactions have ranged in size from $35 million to more than $1
billion, and have represented between 1 percent and 14 percent of issuer shares outstanding. In March
2005, Regency Centers (NYSE: REG), a real estate investment trust (REIT), used the primary forward
structure to lock in proceeds to fund its acquisition of a 35 percent stake in CalPERS shopping center
portfolio. By using the primary forward, Regency was able to raise $175 million with 3.75 million new
shares, or roughly 6 percent of shares outstanding, while preserving flexibility and reducing price risk. The
forward was subject to termination in the event the acquirer was unable to close within four months of the
offering date.
11
Exhibit 11
Valuation of a Fixed-Price Collar
(a) Option Structure
60
Description
Long 1 stock
50
40
Long 0.80
call
Long 1 put
30
Short 1 call
Short 1.33
puts
20
10
Value Paid/(Received)
30.00
(5.49)
4.67
2.42
(1.99)
0
0
10
20
30
40
50
60
29.61
25 1.33*S -1.33*C(X=22.5)+0.8*C*X=37.50.
26 Options valued as European-style instruments, assuming current bidder stock price of 30, stock volatility of 50 percent, risk-free rate of 3.7 percent, 9 months to maturity, and 0 percent
dividend yield.
27 Often collars are constructed with Asian option features, i.e., the payoff isnt dependent upon the bidders share price at close, but rather the average of the bidders share price over,
say, 10 trading days. The prices used to compute the average may even be selected randomly from a larger universe of trading days as a device to discourage risk arbitrage. In any case,
Asian features decrease the value of both put and call options, as the averaging procedure has the effect of dampening volatility. Enrique R. Arzac, Valuation for Mergers, Buyouts and
Restructuring. John Wiley & Sons, 2005. The author addresses Asian options in his discussion of Dow Chemicals contingent value rights offering to Marion-Merrell-Dow in 1991.
12
Resources
Arzac, Enrique R., Valuation for Mergers, Buyouts, and
Restructuring. John Wiley & Sons: New York, 2005.
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