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Executive Summary
This paper examines the failed merger transaction of General Electrics and Honeywell in the
year 2001. In October 2000, GE agreed to acquire Honeywell for $45 billion, where
Honeywells shareowners will receive 1.055 shares of GE stock for one share of Honeywell.
Nevertheless on March 01, 2001 the European Commission announced to review the
transaction in further extent after the US regulators already approved it. Four months later, they
prohibited the merger due to reduced competition in the aerospace industry, which will result
in higher costs for end consumers. The methodology of this paper is mainly based on literary
research and articles from the Anglo-Saxon area as well as the Harvard case study. It also
includes opinions from experts from the banking and finance industry, in particular from the
Hedge Fund, M&A and Sales & Trading area.
One of the key findings of this paper is that with a merger arbitrage strategy on GE &
Honeywell, it is possible to outperform the market by betting on a diminishing spread between
both stocks. Gallinellis equally short position in GE and long position in Honeywell provides
a return on investment around 34%. Nevertheless there are also challenges to overcome such
as a limited trading volume as those trades involves often a high leverage to generate a riskadjusted return. Further to this, the arbitrage spread is acting as an indicator of the possibility
that GE-Honeywell merger goes through. The higher the arbitrage spread, the less the
possibility is. The arbitrage spread experienced a downward trend after the announcement of
this merger. However, 5 days before European Commission formally announced to stringently
investigate this case, the arbitrage spread started to rise significantly.
Additionally, this paper also analyses the projected synergy. The consolidated firm is expected
to gain market power among overlapped products. The deal can also expand the customer base
for both two firms as they can provide bundle offering for complement products. In addition,
synergy can arise from cost savings and improved overall efficiency in operations. GEs former
CEO and chairman, John F. Welchs understanding of GE and the industry helped the firm to
achieve a well-diversified portfolio and become an industry leader.
We adjusted few ratio projections, such as revenue growth rate and dividend payout ratio as
well as correct inappropriate calculations in our discounted cash flow model. We provide
justifications for key assumptions as well as the sources for data inputs. The share price the
adjusted model is estimated to be $34.44 per share, $2.32 higher than the original estimation.
Moreover, we also analysed Honeywells value with the multiple method, arriving at the
conclusion that the GEs bid price ($48.67) is fairly priced, compared to its peers equity value
per share with a maximum of $50.75. We could evaluate Honeywells with-synergy value
using comparable transactions stock premium. The difference between the percentage of stock
premium prior to one month or week to the last day was significant higher than the respective
of the comparable transactions. Therefore, synergys added value to Honeywell can be
displayed in its stocks performance which presents better results to the dates close to the
announcement date.
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Table of Contents
1.
2.
3.
4.
5.
6.
7.
8.
Conclusion ........................................................................................................................ 12
9.
Bibliography ..................................................................................................................... 13
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1.
Investment Strategy
First of all, the main question Jessica Gallinelli has to answer, is what will be the impact on the
absolute and relative difference between the share prices of both companies, also called spread.
In other words, what will be the effect on the stock prices of General Electric (GE) and
Honeywell International Inc. on the latest news of the European Commission. In general, she
is running a market neutral strategy and thus, there are four possibilities: close, reduce, hold or
increase both positions at the same time. In addition she also have to think about how fast the
market will respond to the press release from European Commission antitrust chief Monti
(Schuetz, 2000) as both shares are listed on the US stock market.
One of the key consideration Gallinelli has to think about is what will be the impact on GEs
and Honeywells stock valuation. As John F. Welch Jr., CEO of GE at that time, said after the
merger announcement in October 2000, he expects the deal to be completed by early next year
(Sorkin and Deutsch, 2000). However, as a result of the announcement of EU commissioner
Monti to review the transaction, the merger will not be completed in the first few months of
2001, but rather in the third or fourth quarter 2001. This will not only increase the administrative
merger costs for both parties, but also decrease the likelihood that the deal will be accepted
without any operational merger restrictions. This means that the projected synergies and cost
reductions of total up to 15bn USD by end of 2002 (Sorkin, 2000), which are a substantial part
of Honeywells valuation, cannot entirely taken into account anymore. Therefore the latest news
will result in a widen spread as the probability of the transaction decreases and the uncertainty
for the shareholders increases (ICIS Chemical Business, 2001).
Moreover, another key consideration for her is how to deal with the size of her positions, which
are 1.25% resp. 0.10% of the outstanding shares of Honeywell resp. GE as of March 1, 2001
(Bloomberg, 2015). This is especially crucial when she is going to fully close or substantially
reduce her positions in one or both companies, which will be very difficult due to limited daily
trading volume. More specific, based on data from Bloomberg, the daily average volume in
Honeywell stocks over a 100-day period is 5.96 million respective for GE 18.66 million shares.
As a result, according to Lange (2015), the maximal percentage in a US blue-chip company,
which can be traded without moving stock prices in an unfavourable direction, is around 5%
per trading day. As such, Jessica Gallinelli can only trade 3.0% (299,000 stocks) of her holding
in Honeywell and 9.3% (933,000 stocks) in GE. Therefore, it takes over 11 trading days for GE
and 34 days for Honeywell to fully close both positions and thus it is not possible to react in a
reasonable period of time on the latest news by only trading shares. All calculations are shown
in Table 5 in the appendix.
Additionally, Gallinelli has only a few hours left before the US stock pre-market will open,
particularly the regular market with high trading volume (NASDAQ, 2015). The news start to
make the round in Brussels around 12pm GMT on March 1, 2001 followed by the first report
on Bloomberg from Associated Press (2001) at 2:07 pm GMT. In order to react properly on the
latest news, without selling a substantial part of her positions on the market, which would lead
to highly adverse price movements, there are two more appropriate possibilities: either she
writes (sell) put and/or buys call options on GE and writes call and/or buys put options on
Honeywell. With such a strategy, she will be able to hedge her holdings against unfavourable
stock movements (widen spread) while profit from an additional leverage.
The main reason why Gallinelli does have nearly equally weighted positions in GE and
Honeywell, is a classical arbitrage strategy to explore short-term price differences between
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those two stocks, whereas the stock of Honeywell is following GE with a fixed exchange rate
of 1.055. This strategy is also called merger arbitrage or risk arbitrage, whereas the trader is
betting on decreasing spread between two merging companies (CMC Markets, 2015).
According to Seeking Alpha (2012), [...] it involves identifying target companies that are [...]
bought out by another company, but whose prices have not quite appreciated to the takeover
price. As you can see below in the chart, before March 1, 2001, the spread between the stock
price of GE and the bid price from GE (GE x 1.055) was between $1 and $4 (average $2.4),
which represent a discount rate of about 2% to 8% (average 5.2%). The trend of the spread,
however, is clearly shrinking over time, before end of February 2001 rumours start to circulate
on the stock market about the review through the EU
(Colle, 2015).
Therefore as an arbitrageur, Gallinelli is betting that over time, the price of Honeywells stock
will be the same as the takeover value proposed by GE (spread = 0), which means that there
will not be any arbitrage possibilities anymore. There might be also the chance that other
competitors start to bid for Honeywell, which will result in a rising share prices for Honeywell
and falling GE-stocks as they would have to pay more for the acquisition. Moreover, Jessica
Gallinelli is also following a market neutral strategy with having both short and long positions.
When comparing it to the S&P 500 Index, being long on Honeywell and short on GE, both
positions equally weighted (in theory) performed clearly better and beat the index by 9.37%
over a 87-period, as shown in Figure 2 in the appendix.
Below are five numerical examples, which support her strategy (fees, transaction costs, interest
expenses are excluded and total margin of 100% on the short position according to Aebersold
(2015)).
in thousands
March 01, 2001
Bullish Market Scenario
(GE & HON +10% )
Bearish Market Scenario
(GE & HON -10% )
Worst case Scenario
(GE +10% & HON -10% )
Best case Scenario
(GE -10% & HON +10% )
Realistic Scenario
(HON = GE x 1.055)
General Electric
absolute
relative
416,000 49.87%
Honeywell
absolute relative
418,200 50.13%
Total Portfolio
absolute
relative
834,200 100.00%
Total Liabilities
absolute
relative
583,940 70.00%
Total Equity
absolute
relative
250,260
30.00%
374,400
44.87%
460,020
55.13%
834,420
100.03%
583,940
69.98%
250,480
30.02%
457,600
54.87%
376,380
45.13%
833,980
99.97%
583,940
70.02%
250,040
29.98%
374,400
49.87%
376,380
50.13%
750,780
90.00%
583,940
77.78%
166,840
22.22%
457,600
49.87%
460,020
50.13%
917,620
110.00%
583,940
63.64%
333,680
36.36%
416,000
48.66%
438,880
51.34%
854,880
102.48%
583,940
68.31%
270,940
31.69%
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As this table above shows, the investment strategy of Gallinelli is a merger arbitrage, whereas
she bets on shrinking spread between the proposed bid price of GE and the actual share price
of Honeywell. In the most. In the most realistic scenario, Honeywell will trade 1.055 times the
share of GE which means that her short position in GE did not generate any profit or loss but
the long position in Honeywell increased by 4.95% or $20.7 million. Therefore her market
neutral strategy performed on Investment (ROI) 2.48% and due to the leverage of 2.33 on
Equity (ROE) in total 8.26%. Of special note is that either both stocks are rising or falling, her
equity value stays nearly the same, which shows her market neutral strategy.
2.
This section will review the discounted cash flow (DCF) model, its estimations and forecasts.
The main assumptions are that Honeywell will continue its steady operation over the next few
years and major cost items experience no significant change. We found a number of major
misstatements in the model which distorts the final results.
The model starts with a 5-year revenue forecast. Expenses in the income statement and balance
sheet items are tied to the revenue, as their balances are expressed as a percentage ratio of total
revenue. One can argue the 6% revenue growth for the next four years may seem to be over
optimistic as the past 3 years average is merely 3.6%. However, this argument fails to include
the unrealised effect of the merger between Honeywell and AlliedSignal and Honeywell and
GE. Indeed the revenue growth was 0.8% in 1999, but it may because, during that year, the
firm spent most of the time and effort in completing the merger with AlliedSignal. During 2000,
the next financial year, the firm was back on track of strong revenue growth (5.4%). The
revenue forecast then takes into account of the potential synergy between Honeywell and
AlliedSignal and cautiously generates a mid-term forecast. On the other hand, a 6% revenue
growth forecast does not overestimate the synergy either because the revenue can also be
stimulated by the synergy from the merger with GE. In a longer term, the firms growth is in
line with the overall economy. Therefore, we use the US GDP growth rate for 2000, 4.1%
according to World Bank (2011), as the perpetual revenue growth rate. This also affects the
calculation for terminal value using constant growth model.
Two items are not in line with the revenue growth - rate of borrowing and dividend payout
ratio. The interest rate of firms borrowings in the model uses 10-Year A-rating bond rate as
proxy. According to a number of rating action reports (e.g. Moodys, 1998 and Moodys, 1999),
Honeywell has maintained a firm credit rating at A2. Honeywell is assumed to remain its
healthy debt structure and steady revenue growth. Therefore, we do not expect any negative
inputs on the credit rating. The merger with GE, on the other hand, will have positive effect on
Honeywells credit outlook as GEs support will become a significant rating factor. After the
merger completion, Honeywell would be able to raise finance from the debt market at a cheaper
price as GEs rating was Aaa at that time. Therefore, we set the interest rate at 6%, considering
the US Corporate Bonds yields for Aaa and A are 5.8% and 6.3%, respectively.
The dividend payout ratio projection also needs adjustment. The model averages the dividend
payout ratio from 1997-2000 and assumes the firm would maintain the average rate. According
to Table 6 in the appendix, during the past 9 years between 1992 and 2000, the average dividend
payout ratio is merely 27%. Only in 1999 and 2000, Honeywell paid dividend at a rate above
30%. Consider companies rarely cut their dividend due to the asymmetric market reaction to a
decrease in dividend, Honeywell is more likely to payout dividends at a rate that can sustain.
Therefore, we adjust the forecasted payout ratio 2% down for each of the following years. The
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discussion now turns to the discount rate estimation. The estimation for cost of debt, as
discussed earlier, is decreased to 6% as the expectation of Honeywell receiving a higher credit
rating after its merger with GE.
The model uses capital asset pricing model (CAPM) to determine the cost of equity. The
calculation of debt and equity value in the model is incorrect. The adjusted ratio takes into
consideration of the market value of Honeywells debt and share value. We also disagree with
decision of considering the risk free rate in line with 30-year US Treasury Bond. According to
Koller et al. (2010), the estimates may be misleading as the result is distorted by the illiquidity
of 30-year Treasury. As a result, we take the 10-year US bond yield as the proxy for risk free
rate since the bond itself can better match the cash flow stream that we evaluate. We use the
historical US stock premium as proxy for risk premium. Our estimate for cost of equity has
gone up slightly to 10.39%, compared with 12.49% stated in the original model.
The table below summarises all the adjustments and calculates the correct share price estimate.
The fair value of Honeywell is estimated as $34.44 per share, with synergy. This is slightly
higher than the close price before the merger announcement ($32.34).
5.27%
7.8%
30.5% -33.1%
25:75
Adjusted
Model
4.10%
6.0%
28.5% - 31.1%
12:88
5.29%
6%
7.8%
12.49%
5,251
$36.72
4.87%
4.6%
6.0%
10.39%
4,427
$34.44
Original DCF
Long-term growth rate
Interest rate
Dividend
D/E ratio
CAPM
Risk-free rate
Risk Premium
Cost of Debt
Cost of Equity
Net Debt Calculation
Share Price Projection
Notes
World Banks data
Improved rating
Each year down by 2%
Correct calculation of wD&wE
10-year T-Bill
Historial US stock premium
Improved rating
Cost of Equity part of CAPM
Use current years balance
Up by $2.32 (-6.3%)
3.
Relative Valuation
In the third section, we will use a different method to value Honeywell. For the estimation of
Honeywells stand-alone value, multiple transaction method will be used. In the multiple
transaction method all the firms selected should be comparable. In our case, we were given the
financial data, such as EBIT, EBITDA, Sales and Net Income, of six comparable to Honeywell
firms. These companies are Emerson Electric, Textron, Tyco International, United
Technologies (UT), General Electrics and Honeywell.
In our view not all given firms are appropriate for estimating the Honeywells stand-alone value.
To begin with, Tyco International. that operates in a different industry, as it is a security
services company, while other peer are specialised in the aerospace industry. What is more,
GE is excluded from the analysis as on one hand it is directly involved in the transaction and,
on the other hand, the firm is significantly larger than the given peer firms. Moreover, we
decided to exclude Honeywell from our valuation as we want to calculate its value in
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Several synergies could be achieved through the merger between GE and Honeywell. As GE
is specialised in commercial aircraft engines and Honeywell is the leading aircraft subsystem,
such as avionics system, it could make each firms product portfolio as a perfect complement
to another. Additionally, it has been pointed out by academics that the merger would enable
GE to gain market power in those areas where two firms have overlap in product range, such
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as large regional jet engine (Grant, 2005). This would allow GE to gain higher bargain power
to customers and, eventually, raising the price of their product.
The merged firm could also engage in product bundling to expand the network of both products.
Fox (2002) suggests that once an aircraft manufacturer, like Airbus and Boeing, chooses one
type of engine and other parts, they are more likely to continue using the same brand of product.
Once GE and Honeywell completed the merger, they can pitch the groups product bundling
to customers by offering a discount. The potential merger synergy can, therefore, be achieved
by stimulated revenue as a number of customers who previously purchase competitor's product
will prefer to use GE/Honeywell bundle and stay that way.
The merger synergy could also be achieved through improved efficiency. Firstly, the
transaction allows two firms to share their competitive technology. In the aerospace industry,
it takes years or even decades to develop a core technology and the related costs are always
substantial. Both two firms possessed several unique technology before the merger. By sharing
these innovative technology, it can substantially reduce the consolidated firms R&D costs.
Secondly, indirect expenses, such as administrative cost, could be reduced through removing
the overlap layers in management and central service department. Since two firms have similar
culture and control system (e.g. Six Sigma) throughout operation process, cost savings could
be achieved in a timely and effective manner.
The synergy can also be reflected from the advantage of economic scale. After merger
completion, the consolidated firms operating activities can raise finance from the debt market
at a lower price as the generally better credit outlook of GE at Aaa rating (Moodys, 2002) can
benefit Honeywell. In addition, GE Capitals enormous financial resources can support
Honeywells research as they will be given more space for the development of innovative
technology. GE, on the other hand, will be able to maintain their high credit rating since the
merger will significantly stimulate the growth in revenue and cash flow generation.
As GEs CEO at the time, Welch added unique value to the proposed merger. During the 20year governance, he made significant contribution in restructuring GEs portfolio and made
GEs operations more diversified (Barlett, 2002). His strong understanding in the industry
allows the firm to always keep on the right track of expanding. In addition, Welchs aggressive
cost cutting actions helped GE to save substantial payroll expense (Murray, 2001). It also
allows GE to utilise its resources efficiently in R&D rather than pointless administration. It has
been mentioned by Swaine (2001) that Welchs personality in business and government played
an important role in the GE-Honeywell merger proposal. In fact, the merger between
Honeywell and GE successfully gained support from 11 anti-trust bodies with their approval,
including the Department of Justice. In line with Welchs ambitious, GE kept itself in the front
line of aggressive but valuable M&As. One could argue that, without his contribution to GE, a
proposal at such scale would not even be exist.
5.
20-Oct-2000
20-Oct-2000
Position closed
1-Mar-2001
1-Jul-2001
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254
Page 9
$41.46
$41.46
$41.82
$43.89
$0.36
$2.43
$36
$243
$47.08
$47.08
$41.60
$41.60
$5.48
$5.48
$548
$548
$4,146.00
$4,146.00
$4,708.00
$4,708.00
($4,708.00)
($4,708.00)
$2,902.20
$2,902.20
Capital employed
$1,243.80
$1,243.80
$4,146.00
$4,146.00
$584.00
$791.00
($157.43)
($302.94)
$0.00
$0.00
$0.00
$0.00
$426.57
$488.06
34.30%
39.24%
94.83%
56.39%
Net spread
Results
The return on investment for her position is 34% and 39% for two specific holding period,
respectively as shown in the table above. The short position of GEs share contributed
majority of the return while Honeywells share also provides considerable returns.
6.
Arbitrage Spread
The market will react negatively to the review initiated by European Commission with share
prices of both GE and Honeywell going down instantaneously. Reasonably, before the news
was released by regulators, both stocks had been underperforming for several days. This
preceding decrease is typically because the market had anticipated the bad news. As post-event
drift is mainly after news and is usually very robust (Wesley. Chan, 2000), then after the official
announcement, the stocks will continue drifting downwards unless other good news are
presented to the public or the market revises its expectation.
Concerning arbitrage spread, it is defined as the difference between post-announcement share
price for the target firm and the offer price by the bidder (Betton, Eckbo and Thornburn, 2008).
Based on our formulas below,
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(1)
Equation 1
(2)
Equation 2
we can arrive at formula (3), which interprets that the spread is related inversely to the
possibility that the deal goes through, i.e. with other factors remaining constant, the higher the
probability of consummation is, the narrower the discrepancy (between todays share price for
the acquiree and the bid price) is, or vice versa.
Arbitrage spread = (Pbid - Pstand-alone) x (1 prob.)
(3)
re
ad
$51.87
$50.03
$48.59
$47.46
$41.82
$45.29
$44.19
$45.87
$43.89
$30.00
$32.86
$34.00
$3.65
$3.49
$3.41
$4.15
$1.79
$1.98
$1.00
$1.82
$2.07
83.29%
82.58%
81.64%
76.21%
84.85%
87.04%
92.93%
88.52%
85.11%
80.79%
79.69%
78.31%
71.56%
80.03%
84.07%
91.15%
86.01%
81.26%
79.56%
78.24%
76.61%
69.15%
77.11%
82.45%
90.15%
84.66%
79.09%
Sp
$49.17
$47.42
$46.06
$44.99
$39.64
$42.93
$41.89
$43.48
$41.60
pr
ic
e
$48.22
$46.54
$45.18
$43.31
$40.03
$43.31
$43.19
$44.05
$41.82
Bi
d
G
E
1-Nov-00
15-Nov-00
1-Dec-00
15-Dec-00
2-Jan-01
16-Jan-01
1-Feb-01
15-Feb-01
1-Mar-01
Ho
ne
y
w el
l
Da
te
Equation 3
Stand alone value Honeywell
$35.30
$38.00
$40.00
$42.00
Probability
77.95% 73.66% 69.22% 62.99%
76.32% 71.00% 65.22% 56.55%
74.33% 67.78% 60.28% 48.23%
65.85% 56.10% 44.34% 23.97%
72.55% 53.14% 1.65%
>100%
80.17% 72.83% 62.56% 39.80%
88.71% 83.79% 76.06% 54.24%
82.77% 76.86% 68.98% 52.95%
75.92% 64.88% 46.81%
<0%
$44.00
$47.16
$50.00
53.59%
42.14%
25.69%
<0%
>100%
<0%
<0%
2.67%
>100%
22.44%
<0%
<0%
<0%
>100%
>100%
>100%
>100%
>100%
<0%
<0%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
Therefore, arbitrage spread is an indicator of the possibility of merger. Specifically, when the
arbitrage is small, good opportunities are that the merger will be conducted eventually. While
when arbitrage spread is big, it may, to a large extent, suggest that the deal will not be
consummated at all (Bruner, 2004). Since the arbitrage spread diminishes at the end of an M&A
when target firms share price equals to the share price of the takeover firm, the conclusion
suits best when M&A is done entirely through stock exchange (Value Research, 2012).
Additionally, as probability always fall into the range of 0 and 1, we delete all cells with
probability outside the range, which occurs Honeywells stand-alone values exceed its share
prices. Nevertheless, it is necessary to clarify that even though we delete these values, it is still
possible for this M&A to be conducted. Because the market always leads bidders to purchase
assets of undervalued targets (Betton, Eckbo, Thorburn, 2008) and when the share price is less
than the stand-alone value, it implies that the firm is undervalued by the market.
To be more specific, Figure 1 in Question 1 demonstrates this inverse relationship between
arbitrage spread and possibility as well. From the declaration of GE-Honeywell merger to the
beginning of December 2000, the arbitrage spread decreased continuously from $4.27 to $2.62.
However, the spread leaped back to $4.15 on December 15th as Honeywell pre-announced its
would-be lower-than-expectation quarter earnings (ICIS Chemical Business, 2001). Its bad
performance and customer uncertainty due to divesting business units may well influence GEs
interest in taking it over. Simultaneously, the market updated the prediction that probability of
consummation would be impaired by the news, which explains the abrupt jump in the spread.
Afterwards, the spread did not go against the decreasing trend until EC announced the antitrust
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scrutiny. Since the investigation raised stakeholders concern that this combination would fail
in the end, a significant increase in spread was brought about.
7.
Investment Decision
First of all, as already mentioned in question 1, the whole transaction will not be completed in
the first quarter of 2001 and thus lead to higher merger-related expenses (Elliott, 2001). Further
to this, it also diminishes the potential synergies, which are already projected and reflected the
current value of GE and Honeywell. As a result, those news will clearly affect GE and
Honeywell negatively and will lead to falling stock prices, but even more important for
Gallinelli, it will widen the spread between both companies. This is highly unfavourable for
her positions as the share of Honeywell will no longer have the same correlation to GEs stock
price and thus her merger arbitrage strategy will not work anymore.
In our view, the best strategy from this situation is to reduce/close her long position in
Honeywell and increase instead the short holding in GE to profit from falling stock prices.
However, this strategy is hard to follow due to the limited trading volume, nevertheless as an
interesting alternative, she can buy either put options and write call options on both stocks.
Further to this, buying put options is the better alternative than writing call options as on one
hand the implied volatility will increase after the EU-announcement, which will lead to higher
intrinsic value of the option. On the other hand, Gallinelli would only get the option premium,
which would only partly offset her losses, depending on strike price and time to maturity
(Mullaney, 2009). Unfortunately, she will not running a merger arbitrage strategy anymore,
however she will be able to perform clearly better from the dropping stocks. If she is going to
follow a market neutral strategy as it is probably written in the fund prospectus, another
possibility is to bet on widen spread as the deal will not be completed in the first quarter of
2001 and thus the uncertainty of the transaction will increase, which will result in a widen
arbitrage spread. That means, she has to reverse both positions by selling Honeywell and
buying GE stocks simultaneously. To further enhance this strategy, she has to buy as well put
options on Honeywell and buy call options on GE. As a result, she will be able to generate
profit from a widen arbitrage spread in the short-term.
8.
Conclusion
First of all, the example of Gallinelli shows us what the merger arbitrage strategy is and how
an individual, mostly hedge funds, can generate market neutral profit by betting on diminishing
spread between both companies. Additionally, it taught us the power of regulators in reality, as
EU Commissioner Monti rejected the merger between two US companies, which is a drawback
of the globalisation in general. Moreover it showed us as well how the market reacts on mergers,
in particular the uncertain prospects caused by a delay of the transaction, which often results
in substantial expenses to both parties.
Multiple method for firm valuation requires a carefully choice of industry peers and
comparable financial ratios. While a robust DCF model requires both reasonable projections
for key ratios and, also, accurate calculations through the model. To analyse the synergy of a
merger, one can look at a specific deal. However, in order to achieve a comprehensive
conclusion, an analysis of the wider industry sector is also necessary as it adds valuable insights.
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9.
Bibliography
Aebersold, N. (2015). Margin Account for US blue chips for Hedge Funds - Product offering
of Credit Suisse Investment Banking. [email].
Arzac, E. (2008). Valuation for mergers, buyouts, and restructuring. Hoboken, NJ: John
Wiley & Sons.
Associated Press, (2001). EU Probing Electric-Honeywell Deal. Associated Press.
Barlett, c. (2002). GE's two decade transformation: Jack Welch's Leadership. Harvard
Business School, 9-399-150, p.4.
Betton, S., Eckbo, B. and Thorburn, K. (2008). Corporate Takeovers. [online]
Papers.ssrn.com. Available at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1131033 [Accessed 7 Nov. 2015].
Bruner, R. (2004). Applied Mergers and Acquisitions. [online] Google Books. Available at:
https://books.google.co.uk/books?id=xpzTYgXK3fsC&pg=PA808&lpg=PA808&dq=T
he+ARB+Is+the+Consummate+Economic+Actor&source=bl&ots=4O2oo38FGR&sig
=-SbIIHKxGHqaoJrmZURalRHQelg&hl=zhCN&sa=X&ved=0CCMQ6AEwAGoVChMImpW2K72yAIVi10UCh1E2w2o#v=onepage&q=The%20ARB%20Is%20the%20Consum
mate%20Economic%20Actor&f=false [Accessed 1 Nov. 2015].
Chan, W. (2000). Stock Price Reaction to News and No-News: Drift and Reversal After
Headlines. [online] Available at: http://www.econ.yale.edu/~shiller/behfin/2001-0511/chan.pdf [Accessed 30 Oct. 2015].
Cmcmarkets.co.uk, (2015). What is spread betting? | CMC Markets UK. [online] Available
at: http://www.cmcmarkets.co.uk/en/spread-betting/what-is-spread-betting [Accessed 1
Nov. 2015].
CNN, (2001). EU rejects GE-Honeywell merger - Jul. 3, 2001. [online] Money.cnn.com.
Available at: http://money.cnn.com/2001/07/03/europe/ge_eu/ [Accessed 4 Nov. 2015].
Colle, S. (2015). Spread of M&A Deals. [email].
European Commission, (2001). The Commission prohibits GE's acquisition of Honeywell.
[online] Available at: http://europa.eu/rapid/press-release_IP-01-939_en.htm [Accessed
3 Nov. 2015].
Fox, E. (2002). Mergers in Global Markets: GE/Honeywell and the Future Merger Control.
Journal of International Law, 23(3).
SMM122
Page 13
SMM122
Page 14
SMM122
Page 15
10.
Appendix
General Electrics
9,908,802,000
Shares outstanding
Stake in the company with 10m
shares
100 days avg. trading volume
max. daily trading volume (5%)
Duration to close the position
Honeywell
797,486,000
0.1009%
1.2539%
18,658,073
932,904
10.72 days
5,964,635
298,232
33.53 days
1992
1993
1994
1995
1996
1997
1998
1999
2000
Pay-out ratio
26.7%
24.7%
23.7%
24.8%
25.6%
25.2%
25.2%
34.2%
36.1%
SMM122
Page 16
Multiple
method methods - original
Table
7: transaction
Multiple transaction
Original Peergroup
3,629
EBIT
Table
9: Multiple 4,624
transaction
methods - resultEV/Net
EV/Sales EV/EBIT EV/EBITDA
Net Income
1,659
Income
EV/Net
Enterprise value (Refined
Sales
25,023 EV/Sales EV/EBIT EV/EBITDA
36,198.5 49,097.0
30,796.4 Income
56,311.6
Peergroup)
EBITDA
3,629
Sales
25,023
EBIT
4,624
Enterprise value (Original
EBITDA
3,629
60,400.6 63,277.9
39,521.1 54,882.5
Net IncomePeergroup)
1,659
EBIT
4,624
Enterprise value (Refined
Net Income
1,659
36,198.5 49,097.0
30,796.4 56,311.6
Peergroup)
Enterprise value (Refined
36,198.5 49,097.0
30,796.4 56,311.6
Enterprise
value (Original
Peergroup)
60,400.6 63,277.9
39,521.1 54,882.5
Peergroup)
Enterprise value (Original
60,400.6 63,277.9
39,521.1 54,882.5
Peergroup)
Average
Average
43,100.9
54,520.5
43,100.9
43,100.9
54,520.5
54,520.5
SMM122
US WEST
Quest
Texaco
Chevron
32.48
50.11
49.77
17.68
22.55
17.51
Average
25.08
36.33
33.64
Honeywell's
premium over
stock price
17.39
55.94
48.70
Page 17
High
Enterprise Value
Equity Value
Low
Low
High
Per share
2000 revenue
1.01
25,273
50,046
Per share
2000 EBIT
$36.85
17,019
41,792
21
52.15
27,042.54
12.26
23,982
35,297
15,728
20
33.74
6.35
9.67
19,279
29,358
11,025
21,104.12
14
26.33
19.57
60.36
32,467
100,137
24,213
91,883
30
52.15
28,734
47,073
Per share
2000 net income
$29,533
$30.37
8.33
Per share
2000 EBITDA
High
$24,340
Per share
Equity value as a multiple of:
2000 EPS
17.32
28.37408
Per share
2000 book value
Per share
Median equity value
35.85
1.55
4.19
15,046
18.77
17,019
Per share
$21.24
58.73
40,672
50.75
$40,672
$50.75
SMM122
Page 18
Date Honeywell
24-Oct-00
25-Oct-00
26-Oct-00
27-Oct-00
30-Oct-00
31-Oct-00
1-Nov-00
6-Nov-00
7-Nov-00
8-Nov-00
9-Nov-00
10-Nov-00
13-Nov-00
14-Nov-00
15-Nov-00
16-Nov-00
17-Nov-00
20-Nov-00
21-Nov-00
22-Nov-00
27-Nov-00
29-Nov-00
30-Nov-00
1-Dec-00
4-Dec-00
5-Dec-00
6-Dec-00
7-Dec-00
8-Dec-00
11-Dec-00
12-Dec-00
13-Dec-00
14-Dec-00
15-Dec-00
18-Dec-00
19-Dec-00
20-Dec-00
22-Dec-00
26-Dec-00
28-Dec-00
29-Dec-00
2-Jan-01
3-Jan-01
4-Jan-01
5-Jan-01
8-Jan-01
9-Jan-01
10-Jan-01
11-Jan-01
12-Jan-01
16-Jan-01
17-Jan-01
18-Jan-01
19-Jan-01
22-Jan-01
24-Jan-01
25-Jan-01
26-Jan-01
29-Jan-01
30-Jan-01
31-Jan-01
1-Feb-01
2-Feb-01
5-Feb-01
6-Feb-01
7-Feb-01
8-Feb-01
9-Feb-01
12-Feb-01
13-Feb-01
14-Feb-01
15-Feb-01
16-Feb-01
20-Feb-01
21-Feb-01
22-Feb-01
23-Feb-01
26-Feb-01
27-Feb-01
28-Feb-01
1-Mar-01
$48.05
$47.09
$47.04
$46.42
$48.45
$48.50
$48.22
$47.66
$48.90
$48.22
$48.39
$48.11
$45.63
$46.76
$46.54
$46.59
$46.14
$44.55
$45.12
$43.65
$43.99
$43.70
$44.10
$45.18
$45.80
$47.89
$47.89
$47.61
$49.30
$49.93
$47.16
$47.16
$45.74
$43.31
$45.00
$44.22
$41.61
$43.20
$43.42
$43.37
$42.80
$40.03
$43.54
$43.48
$42.46
$41.33
$40.43
$40.88
$42.86
$42.06
$43.31
$43.42
$44.22
$43.77
$42.57
$42.86
$42.80
$42.01
$41.43
$42.85
$42.74
$43.19
$43.15
$44.71
$44.55
$43.92
$44.13
$42.70
$44.38
$44.05
$43.12
$44.05
$43.78
$44.68
$44.20
$43.77
$42.69
$44.21
$43.73
$42.44
$41.82
GE
Bid price
Spread
$48.21
$47.81
$47.08
$47.19
$48.77
$49.50
$49.17
$49.22
$49.62
$49.28
$49.28
$48.66
$46.46
$47.64
$47.42
$47.53
$46.86
$45.21
$45.84
$43.86
$44.37
$44.88
$44.76
$46.06
$46.63
$48.89
$48.72
$48.32
$49.85
$49.95
$47.70
$47.87
$46.46
$44.99
$46.06
$45.28
$42.85
$44.15
$44.54
$43.89
$43.44
$39.64
$43.32
$43.55
$42.87
$41.28
$40.44
$40.49
$42.19
$41.40
$42.93
$42.31
$43.16
$42.59
$41.45
$41.96
$41.63
$40.44
$40.21
$41.91
$41.66
$41.89
$41.93
$43.36
$43.13
$42.54
$42.71
$41.37
$43.05
$42.73
$41.92
$43.48
$42.59
$43.21
$42.86
$42.68
$41.84
$43.48
$43.49
$42.13
$41.60
$50.86
$50.44
$49.67
$49.79
$51.45
$52.22
$51.87
$51.93
$52.35
$51.99
$51.99
$51.34
$49.02
$50.26
$50.03
$50.14
$49.44
$47.70
$48.36
$46.27
$46.81
$47.35
$47.22
$48.59
$49.19
$51.58
$51.40
$50.98
$52.59
$52.70
$50.32
$50.50
$49.02
$47.46
$48.59
$47.77
$45.21
$46.58
$46.99
$46.30
$45.83
$41.82
$45.70
$45.95
$45.23
$43.55
$42.66
$42.72
$44.51
$43.68
$45.29
$44.64
$45.53
$44.93
$43.73
$44.27
$43.92
$42.66
$42.42
$44.22
$43.95
$44.19
$44.24
$45.74
$45.50
$44.88
$45.06
$43.65
$45.42
$45.08
$44.23
$45.87
$44.93
$45.59
$45.22
$45.03
$44.14
$45.87
$45.88
$44.45
$43.89
$2.81
$3.35
$2.63
$3.37
$3.00
$3.72
$3.65
$4.27
$3.45
$3.77
$3.60
$3.23
$3.39
$3.50
$3.49
$3.55
$3.30
$3.15
$3.24
$2.62
$2.82
$3.65
$3.12
$3.41
$3.39
$3.69
$3.51
$3.37
$3.29
$2.77
$3.16
$3.34
$3.28
$4.15
$3.59
$3.55
$3.60
$3.38
$3.57
$2.93
$3.03
$1.79
$2.16
$2.47
$2.77
$2.22
$2.23
$1.84
$1.65
$1.62
$1.98
$1.22
$1.31
$1.16
$1.16
$1.41
$1.12
$0.65
$0.99
$1.37
$1.21
$1.00
$1.09
$1.03
$0.95
$0.96
$0.93
$0.95
$1.04
$1.03
$1.11
$1.82
$1.15
$0.91
$1.02
$1.26
$1.45
$1.66
$2.15
$2.01
$2.07
$30.00
$32.86
$34.00
$44.00
$47.16
$50.00
86.52%
83.61%
86.63%
82.99%
86.00%
83.25%
83.29%
80.54%
84.57%
82.85%
83.63%
84.88%
82.20%
82.72%
82.58%
82.36%
83.04%
82.22%
82.35%
83.88%
83.22%
78.97%
81.87%
81.64%
82.31%
82.90%
83.60%
83.95%
85.43%
87.81%
84.43%
83.70%
82.78%
76.21%
80.67%
80.02%
76.35%
79.62%
78.99%
82.00%
80.86%
84.85%
86.23%
84.54%
81.82%
83.61%
82.36%
85.56%
88.63%
88.18%
87.04%
91.69%
91.54%
92.22%
91.55%
90.13%
91.96%
94.83%
92.02%
90.40%
91.32%
92.93%
92.37%
93.43%
93.86%
93.55%
93.83%
93.07%
93.27%
93.17%
92.23%
88.52%
92.28%
94.18%
93.31%
91.63%
89.74%
89.53%
86.45%
86.11%
85.11%
84.39%
80.95%
84.36%
80.12%
83.86%
80.78%
80.79%
77.63%
82.31%
80.30%
81.18%
82.54%
79.05%
79.89%
79.69%
79.44%
80.12%
78.80%
79.10%
80.46%
79.79%
74.83%
78.27%
78.31%
79.22%
80.30%
81.07%
81.42%
83.32%
86.05%
81.89%
81.06%
79.73%
71.56%
77.17%
76.20%
70.88%
75.38%
74.75%
78.18%
76.65%
80.03%
83.17%
81.17%
77.63%
79.24%
77.22%
81.37%
85.84%
85.06%
84.07%
89.67%
89.64%
90.38%
89.34%
87.66%
89.88%
93.33%
89.64%
87.98%
89.08%
91.15%
90.46%
91.97%
92.47%
92.02%
92.39%
91.24%
91.74%
91.57%
90.28%
86.01%
90.46%
92.88%
91.77%
89.67%
87.14%
87.24%
83.48%
82.69%
81.26%
83.33%
79.63%
83.22%
78.68%
82.80%
79.57%
79.56%
76.20%
81.20%
79.04%
79.99%
81.39%
77.45%
78.47%
78.24%
77.98%
78.64%
77.03%
77.43%
78.63%
77.98%
72.67%
76.39%
76.61%
77.66%
79.01%
79.83%
80.16%
82.29%
85.20%
80.62%
79.74%
78.19%
69.15%
75.38%
74.22%
67.91%
73.14%
72.52%
76.15%
74.39%
77.11%
81.52%
79.36%
75.35%
76.75%
74.21%
78.93%
84.30%
83.29%
82.45%
88.56%
88.61%
89.37%
88.08%
86.29%
88.71%
92.45%
88.23%
86.64%
87.83%
90.15%
89.39%
91.19%
91.72%
91.18%
91.60%
90.20%
90.91%
90.70%
89.19%
84.66%
89.46%
92.18%
90.93%
88.60%
85.69%
86.01%
81.89%
80.79%
79.09%
81.93%
77.88%
81.70%
76.77%
81.41%
78.00%
77.95%
74.34%
79.77%
77.41%
78.43%
79.88%
75.32%
76.61%
76.32%
76.06%
76.68%
74.62%
75.19%
76.10%
75.50%
69.72%
73.82%
74.33%
75.57%
77.34%
78.20%
78.52%
80.97%
84.10%
78.95%
78.01%
76.12%
65.85%
72.97%
71.53%
63.70%
70.05%
69.47%
73.34%
71.24%
72.55%
79.21%
76.85%
72.13%
73.09%
69.67%
75.24%
82.08%
80.70%
80.17%
86.97%
87.16%
87.93%
86.25%
84.30%
87.01%
91.12%
86.08%
84.69%
86.00%
88.71%
87.85%
90.09%
90.67%
89.98%
90.48%
88.67%
89.75%
89.47%
87.62%
82.77%
88.04%
91.19%
89.74%
87.08%
83.59%
84.29%
79.67%
78.06%
75.92%
59.02%
47.98%
53.62%
41.83%
59.71%
54.73%
53.59%
46.17%
58.69%
52.81%
54.94%
56.02%
32.50%
44.09%
42.14%
42.15%
39.36%
14.88%
25.68%
<0%
<0%
<0%
3.10%
25.69%
34.65%
51.33%
52.57%
51.74%
61.69%
68.18%
49.97%
48.59%
34.69%
<0%
21.77%
5.83%
<0%
<0%
<0%
<0%
<0%
>100%
<0%
<0%
<0%
>100%
>100%
>100%
<0%
>100%
<0%
<0%
14.34%
<0%
>100%
<0%
>100%
>100%
>100%
<0%
>100%
<0%
<0%
40.69%
36.61%
<0%
12.28%
>100%
26.80%
4.63%
<0%
2.67%
<0%
42.86%
16.43%
<0%
<0%
11.22%
<0%
<0%
>100%
23.98%
<0%
<0%
<0%
30.01%
26.43%
22.44%
10.43%
33.49%
21.90%
25.42%
22.69%
<0%
<0%
<0%
<0%
<0%
<0%
<0%
>100%
>100%
<0%
<0%
<0%
<0%
16.46%
17.16%
11.72%
39.37%
50.00%
-0.09%
-0.09%
<0%
<0%
<0%
<0%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
<0%
<0%
>100%
>100%
<0%
<0%
<0%
<0%
<0%
<0%
<0%
<0%
>100%
<0%
<0%
<0%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
<0%
<0%
<0%
<0%
<0%
<0%
<0%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
>100%
78.14%
73.07%
77.47%
71.44%
77.68%
73.83%
73.66%
69.36%
75.96%
73.05%
74.27%
75.81%
69.27%
71.45%
71.00%
70.73%
71.17%
67.55%
68.72%
68.30%
67.99%
60.97%
66.15%
67.78%
69.68%
72.83%
73.81%
74.05%
77.44%
81.17%
74.33%
73.26%
70.27%
56.10%
66.08%
63.66%
50.09%
60.62%
60.29%
64.67%
61.31%
53.14%
71.92%
68.97%
61.71%
60.00%
52.10%
61.06%
74.65%
71.52%
72.83%
81.66%
82.56%
83.23%
79.76%
77.54%
81.09%
85.97%
77.57%
78.04%
79.65%
83.79%
82.58%
86.64%
87.31%
86.05%
86.84%
83.25%
86.01%
85.45%
82.24%
76.86%
83.38%
88.05%
85.90%
82.11%
76.37%
78.89%
72.70%
68.87%
64.88%
74.11%
67.91%
72.81%
65.61%
73.78%
69.54%
69.22%
64.22%
72.07%
68.55%
69.97%
71.54%
62.45%
65.89%
65.22%
64.96%
65.06%
59.12%
61.24%
58.19%
58.59%
50.35%
56.77%
60.28%
63.08%
68.14%
69.21%
69.32%
73.86%
78.21%
69.36%
68.17%
63.67%
44.34%
58.18%
54.31%
30.92%
48.65%
48.93%
53.46%
48.03%
1.65%
62.08%
58.53%
47.06%
37.46%
16.14%
32.39%
63.41%
56.02%
62.56%
73.75%
76.26%
76.43%
68.91%
67.01%
71.43%
75.44%
59.05%
67.61%
69.34%
76.06%
74.36%
81.99%
82.69%
80.33%
81.64%
74.07%
80.85%
79.72%
73.84%
68.98%
76.64%
83.77%
80.50%
74.99%
64.96%
71.70%
63.41%
54.87%
46.81%
68.27%
60.31%
65.72%
56.77%
68.24%
63.59%
62.99%
57.02%
66.67%
62.26%
63.96%
65.44%
51.74%
57.63%
56.55%
56.36%
55.67%
44.76%
49.05%
38.62%
41.37%
31.79%
40.22%
48.23%
52.82%
61.49%
62.66%
62.49%
68.92%
74.13%
61.99%
60.69%
53.31%
23.97%
45.50%
38.47%
<0%
26.21%
28.46%
31.83%
20.89%
>100%
41.59%
37.51%
14.25%
<0%
<0%
<0%
34.26%
3.58%
39.80%
53.85%
62.82%
60.36%
32.95%
37.92%
41.67%
1.51%
<0%
38.37%
37.92%
54.24%
51.43%
72.37%
72.81%
66.67%
69.63%
42.54%
69.64%
66.56%
50.32%
52.95%
60.70%
74.72%
68.38%
58.47%
32.22%
57.09%
44.57%
17.98%
<0%
SMM122
Page 19