Reading the Tea Leaves in M&A Litigation

A Q&A with Analysis Group Managing Principal Gaurav Jetley

M&A activity appears to be returning along with litigation related to valuation, corporate governance, and failed deals.

Managing Principal Gaurav Jetley, who specializes in securities valuation, M&A analysis, and risk management, has conducted economic analyses concerning M&A transactions, notably in the recent Ventas, Inc. v. HCP, Inc. matter.

Below, he discusses the role of merger arbitrage analysis, an established tool in trading and investment that can also be highly useful in M&A litigation. Mr. Jetley recently published research on merger arbitrage spreads, "The Shrinking Merger Arbitrage Spread: Reasons and Implications," in Financial Analysts Journal.

Q: What can merger arbitrage analysis tell us about an M&A deal?

Mr. Jetley: Arbitrage spread is a widely accepted indicator of deal risk. We can look at the spread – which is the difference between the offer price and the market price after the transaction is announced – to gauge the market's belief that a particular deal will go through. A low positive spread indicates high chances of success; a large spread suggests a low chance of success. In addition, the spread provides information about the possibility of topping bids coming in. More specifically, a low positive arbitrage spread that becomes negative suggests that a topping bid is likely. Consider this: Company A bids $10 for each share of Company B. At some point after the bid is announced, Company B's stock starts trading at $10.50 (i.e., the arbitrage spread becomes negative). That suggests that the market expects either Company A to increase its bid, or that another party will bid more than $10 for Company B.

Q: At what point can an analysis of the merger arbitrage spread provide insight about the deal's potential and risk?

Mr. Jetley: Arbitrage spread provides useful information about deal risk starting right after when a deal is announced and continuing until the deal is consummated or terminated. In fact, on average, the arbitrage spread of deals widens several days or weeks before the merger is officially terminated. Similarly, in a number of instances, arbitrage spreads turn negative prior to the announcement of a topping bid.

Q: This analysis has become an established principle in the fund community. How can it be used as a critical litigation tool?

Mr. Jetley: Analysis of arbitrage spread can be very useful in litigations where deal risk is a critical issue. For example, if counsel wants to determine if a party to a particular transaction had "a reasonable expectation" that the transaction will close, an analysis of arbitrage spread will enable one to reach a fairly robust conclusion regarding the likelihood of success. In addition, we've seen cases where a claim is made that the board of the selling firm was derelict in its duty by agreeing to sell the firm for a particular price. In such a case, you can look at the arbitrage spread to gauge the market's assessment of the adequacy of the price. Again, the arbitrage spread of deals where the market expects that the offer price will be increased is likely to be negative. ■