uploads///TEG WEC arb spread

Should you get involved in the Integrys–Wisconsin Energy deal?


Jul. 2 2014, Published 1:54 p.m. ET

Merger spread analysis

In merger arbitrage, you’ll generally buy the acquired company’s stock and sell short the acquiring company’s stock. When the deal closes, you’ll exchange the acquired company’s stock with the acquiring company’s stock and cash. Then, you’ll deliver the shares of the stock you received to close your short position. So how will this play out when you look at the Integrys–Wisconsin Energy deal?

What you can expect from the Integrys-Wisconsin deal

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In the chart above, you can see the cash flows and timing involved in this kind of deal. These prices are based on the close of Monday, June 30. First of all, you’d be buying Integrys (TEG) for $71.13 and selling short 1.128 shares of Wisconsin Energy (WEC), which is trading at $46.92. Given that Wisconsin Energy is an easy borrow, there should be no cost of carry on the short side.

It’s important for you to remember that to short a stock, you need to find a borrow on the stock. If your broker can’t find you a “locate,” you’ll have to find a way to set up the position using options. If there’s no borrow and there are no options on the stock, you’re out of luck unless you’re willing to take market risk.

When you’re short a stock, you’re also short the dividend. So, you have to factor in the dividends you’re short as a cost of carry. On the other side of the coin, you’d be long Integrys and receive its dividend. As you can see from the chart above, there’s a modestly positive carry on the trade. This is a slight benefit if the deal drags on longer than expected.

Use different timing estimates

As an investor, you should always do these calculations based on different timing estimates. Integrys and Wisconsin Energy are guiding for the end of third quarter 2015. But that’s a point estimate. Some things are simply out of the companies’ control—particularly state public utility commission reviews and SEC approval of the proxy statement.

Other must-know merger arbitrage resources

You can find Market Realist’s helpful primer on merger arbitrage analysis here.

Other important merger spreads you should consider include the Covidien (COV) and Medtronic (MDT) deal as well as the DIRECTV (DTV) and AT&T (T) deal. Check out our analysis of the Covidien-Medtronic deal.


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