What’s the Expected Return from Time Warner Cable–Charter Spread?



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 Time Warner Cable–Charter deal?

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What you can expect from the Time Warner Cable–Charter deal

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 Tuesday, May 26.

First of all, you’d be buying Time Warner Cable (TWC) for $183.73 and selling short .5409 shares of Charter (CHTR), which is trading at $179.49. Assuming Charter is an easy borrow, there should be no cost of carry on the short side.

Take note that Charter stock will be exchanged for new Charter stock at a ratio of .9042. If you buy TWC naked, or in other words, you don’t hedge with CHTR stock, the actual consideration you’ll receive is $100 + (.5409 * .9042 = .4891) shares of Charter. However, if you are hedged, the number of shares you are short will decrease by .9042 after the deal, so you’ll still be able to collapse the position.

There is also an election for $115 + .4562 CHTR available, which will make sense for investors if Charter stock falls. It appears there are no limits to this election, or in other words, no proration.

Use different timing estimates

As an investor, you should always do these calculations based on different timing estimates. Time Warner Cable and Charter are guiding for an end-of-the-year close. But that’s a point estimate. Some things are simply out of the companies’ control, particularly regulatory reviews and SEC (Securities and Exchange Commission) approval of the proxy statement. That timing estimate is very, very aggressive for a deal like this. Investors should expect a typical utility deal timeline of 12–18 months. In this spread, I’m assuming an end-of-2Q16 close.

For a primer on risk arbitrage investing, read Merger arbitrage must-knows: A key guide for investors. Investors who are interested in trading in the tech sector should look at the S&P SPDR Tech ETF (XLK).


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