When the market price for a stock is below a tender offer's price, is it free money (riskless) to buy shares & tender them?

Question

For instance, on March 11, 2014, Jos A Bank (JOSB) agreed to be acquired by Men's Wearhouse for $65/share in cash. A tender offer to existing shareholders was set to expire on March 19th. On March 20th, Men's Wearhouse extended the tender offer for $65/share to April 9th. On April 10th, it again extended the tender offer to April 23rd.

I purchased shares of JOSB on April 1 at $64.31. The day after I told my broker I wanted to tender all my shares. The shares remained in my account until April 9th, after which the shares are no longer in my account, as the broker says they have been tendered and they are waiting to receive cash from the depository to transfer to my account. I don't know when I will actually receive the cash, but assuming it's just another week or so, I made 1.07% return in a pretty short time period. Didn't I?

My question is, given the deal is for all cash and the next tender expiration is near (April 23rd is 6 days from now), why not buy more shares at the current price of $64.44, tender them, and receive $65 in cash in a couple weeks? My brokerage only charges me 0.5 cent/share so transaction costs are not an issue. ($65 - $64.445)/$64.445 equals a 0.86% profit in just a couple weeks for a what seems to me a riskless trade.

If this is the case, why isn't JOSB trading closer to $65/share as this riskless profit should be arbitraged away?

Answer 1

It is not a "riskless" transaction, as you put it. Whenever you own shares in a company that is acquiring or being acquired, you should read the details behind the deal. Don't make assumptions just based on what the press has written or what the talking heads are saying.

There are always conditions on a deal, and there's always the possibility (however remote) that something could happen to torpedo it.

I found the details of the tender offer you're referring to. Quote:

Terms of the Transaction

[...] The transaction is subject to certain closing conditions, including the valid tender of sufficient shares, which, when added to shares owned by Men’s Wearhouse and its affiliates, constitute a majority of the total number of common shares outstanding on a fully-diluted basis. Any shares not tendered in the offer will be acquired in a second step merger at the same cash price as in the tender offer. [...]

Financing and Approvals

[...] The transaction, which is expected to close by the third quarter of 2014, is subject to satisfaction of customary closing conditions, including expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Act. Both Men’s Wearhouse and Jos. A. Bank are working cooperatively with the Federal Trade Commission to obtain approval of the transaction as soon as possible. [...]

Essentially, there remains a small chance that one of these "subject to..." conditions fails and the merger is off. The chance of failure is likely perceived as small because the market price is trading close to the deal price. When the deal vs. market price gap is wider, the market would be less sure about the deal taking place.

Note that when you tender your shares, you have not directly sold them when they are taken out of your account. Rather, your shares are being set aside, deposited elsewhere so you can no longer trade them, and later, should the conditions be satisfied, then you will be paid for your shares the deal price.

But, should the deal fall apart, you are likely to get your shares deposited back into your account, and by that time their market value may have dropped because the price had been supported by the high likelihood of the transaction being completed.

I speculated once on what I thought was a "sure deal": a large and popular Canadian company that was going to be taken private in a leveraged buyout by some large institutional investors with the support of major banks. Then the Global Financial Crisis happened and the banks were let off the hook by a solvency opinion. Read the details here, and here. What looked like a sure thing wasn't. The shares fell considerably when the deal fell apart, and took about four years to get back to the deal price.

Answer 2

That price is the post-tender price, which already reflects arbitrage. It's less than $65 on the market because that's the highest offer out there and the market price reflects the risk that the $65 will not be paid. It also reflects the time value of money until the cash is disbursed (including blows to liquidity).

In other words, you are buying the stock burdened with the risk that it might rapidly deflate if the deal falls through (or gets revived at a lower price) or that your money might be better spent somewhere other than waiting for the i-bank to release the tender offer amount to you.

Two months ago JOSB traded around $55, and four months ago it traded around $50. If the deal fails, then you could be stuck either taking a big loss to get out of the stock or waiting months (or longer) in the hope that another deal will come along and pay $65 (which may leave you with NPV loss from today). The market seems to think that risk is pretty small, but it's still there.

If the payout is $65, then you get a discount for time value and a discount for failed-merger risk. That means the price is less than $65. You can still make money on it, if the merger goes through. Some investors believe they have a better way to make money, and no doubt the tender offer of the incipient merger of two publicly traded companies is already heavily arbitraged. But that said, it may still pay off.

Tender offer arbitrage is discussed in this article.