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$42.08 Isn't $42.08: Coventry and Aetna



August 22, 2012 – Comments (1)

Earlier this week, Aetna (AET) announce it was buying Coventry Health (CVH) in a deal valued at $42.08 per CVH share. But, it isn't an all cash deal and the value is partly based on AET share price.  The bid is $27.30 per CVH share plus 0.3885 share of AET.  At Friday's close, the value was $42.08, but that changes every time AET share price moves.

At today's close, 27.30 + 0.3885*AET =  $42.67 and a few bits for a share of CVH.  CVH closed today at $41.89, a 1.9% discount to the deal price.  That narrow spread indicates the market expects this deal to go through. 

The deal also sets up the possibility of an arbitrage trade, but a tough one given the tight spread.  Arb traders would short AET and buy enough CVH to cancel the short exposure.  For example, short 3885 shares of AET and buy 10,000 shares of CVH - the trader would need to tie up a fair amount of cash until the deal closes.  When (and if) the deal closes, the AET shares that come as part of the CVH buy cancel the short position and the trader captures the spread minus trading expenses.  Here's how the numbers run:

Short 3885 AET:  brings in $153,729
Buy 10,000 CVH: costs $418,900
Out of pocket:  $265,171

After deal goes through the trader gets:
$273,000 in cash and 3885 AET shares for the 10,000 CVH shares.  The new AET shares cancel the short position and the trader is ahead $7800 minus expenses.

However, they call it RISK arbitrage for a reason.  There are a number of possible outcomes.
1. The deal goes through as planned and the trader makes a small profit.
2. Something happens to squelch the deal, CVH probably heads back to the pre-bid price and the trader curses bitterly.
3. Some other suitor comes along with a sweeter bid and the trader pops a bottle of champagne.
4. Deal drags on seemingly forever or some unforseen situation crops up.

With a spread this tight, trading costs would chew up any profits for most individual investors.  Someone who was considering buying AET might want to consider buying CVH instead, but in this case the cash piece would end up making that more trouble than it's likely worth - and it involves assuming the risk of the deal falling apart.

No investable intelligence here, but I'm a bit of a geek and like running calcs on arb spreads.

Disclosure:  No position in AET or CVH, and no plans to play the arb trade or take a position in either company.

Fool on!


1 Comments – Post Your Own

#1) On August 23, 2012 at 3:40 PM, elcid24 (59.67) wrote:

Good read Russ...interesting stuff.

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