That was a true arbitrage opportunity because the gain was instant and the time related risk was as near zero as one can get. My article on arbitrage appearing on the popular deepdive site includes a customizable downloadable spreadsheet that auto tracks such opportunities almost in real time.
I referred to M&A opportunities as near arbitrage. I use that term because it resembles an arbitrage opportunity when the current share price difference is favourable compared to the conversion rate of the M&A. Using an example, Company A has a share price of $20 and announces M&A with company B. Company B’s share price is $7 and the terms of the M&A are all stock and each share of Company B will be exchanged for 0.5 shares of Company A. This assigns an inferred price of $10 per share for Company B. So long as Company B’s share price is less than $10 there is a gain to be made on the premium offer.
The best-case scenario is for a shareholder who already owns shares of Company A and has no intention to sell them for quite some time. They could sell their shares and buy shares of Company B and then gain on the conversion back to Company A. In this example, let’s assume the shareholder owns 1,000 shares of Company A and sells them for $20 each for $20,000. They then buy 2,856 shares of Company B with the $20,000. The exact math is 2,857.14 but one cannot buy 0.14 shares and any fractional shares are lost on the conversion. So, 2,857 or 2,856 will convert to the same number of shares in Company (2,857 x 50% = 1,428.50 = 1,428 shares). The money for the 1.14 shares not bought we can assume paid for the transaction fees. 2,856 shares of Company B will become 1,428 shares of Company A when the deal closes.
This shareholder just increased their share count by 42.8% and to them it was risk free and involved no new money. The easy reconciliation is the share price difference between the $7 current share price and the $10 effective share price is $3 and $7 to $10 is a 42.8% increase. You can see why some erroneously refer to this as “arbitrage”. If a favour-able spread still existed seconds before the deal closed then perhaps you could refer to as such. There is also potential further upside if another suiter appears with a better offer.
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