What Is Merger Arbitrage? Deal Spreads, Deal Risk and the Filings Behind Them

Merger arbitrage is buying a takeover target's shares after a deal is announced to earn the spread between their market price and the price the buyer agreed.

When one company agrees to buy another, the target's shares usually trade close to the agreed price but a little below it until the deal closes. That gap is the deal spread. This page covers how the spread is measured in a cash deal, a stock deal and a mixed deal, why it exists at all, how it is turned into an annualised figure, the filings that mark each step from signing to closing, what happens when a deal breaks (with a real example from the filings), how collars change a stock deal, and where Kresmion shows deal spreads. It explains how the spread is read. It is descriptive throughout.

The deal spread in cash, stock and mixed deals

The spread compares what a target share will be worth if the deal closes, the deal value, with what it costs now.

Cash deal. The deal value is the cash price per share in the merger agreement. If a buyer agrees to pay $50.00 cash and the target trades at $48.00, the gross spread is $2.00, or $2.00 / $48.00 = 4.17 percent.

Stock deal. Each target share converts into a fixed number of acquirer shares, the exchange ratio, so the deal value moves with the acquirer's price. With a ratio of 0.5 and the acquirer at $80.00, the deal value is 0.5 x $80.00 = $40.00. If the target trades at $38.50, the spread is $1.50, or 3.90 percent. Because the deal value moves every time the acquirer's price does, arbitrageurs in stock deals commonly pair the target purchase with a short sale of the acquirer's shares at the exchange ratio, here half an acquirer share per target share, so that the gap, not the acquirer's price, is what changes.

Mixed deal. Some cash plus some stock: $20.00 cash plus 0.25 acquirer shares, with the acquirer at $80.00, is worth $20.00 + $20.00 = $40.00 per target share. The spread is measured against that sum.

All figures in this section are hypothetical. Real deals add details that change the arithmetic: dividends paid by either company before closing, a contingent value right (an extra payment only if a future event happens), or an election letting each holder choose cash or stock, subject to limits on the total.

Why the spread exists

If the deal were certain to close tomorrow, the spread would be close to zero. It is not, for several reasons:

• Break risk. The deal may fail. If it does, the target's price can fall back toward where it traded before the announcement, a move that can be much larger than the spread. The spread is in part the market's price for that risk.
• Time. Money tied up in a target share until closing could have earned interest elsewhere, so even a near-certain deal trades below the deal value by roughly the interest over the waiting period.
• Regulatory risk. Antitrust reviewers, and in some industries sector regulators or foreign-investment reviewers, can delay a deal, demand changes or sue to block it.
• Financing risk. A buyer that is borrowing to pay may fail to raise the money, though a merger agreement can make financing the buyer's problem rather than a condition.
• The vote and other conditions. Shareholders may vote the deal down, and each agreement lists conditions that must be met before closing.
• A higher bid. The spread can turn negative, the target trading above the deal price, when the market prices a chance of a competing offer or a raised one.

Annualising a spread

A 4 percent spread earned in two months and one earned in two years are very different, so spreads are usually also shown per year. Take the cash example above, $50.00 offered against a price of $48.00, with 200 days to the expected closing:

• Simple annualisation: $2.00 / $48.00 x 365 / 200 = 7.60 percent a year.
• Compounded: (1 + $2.00 / $48.00) ^ (365 / 200) - 1 = 7.73 percent a year.

Both assume the deal closes on the expected date at the agreed price. The annualised figure is very sensitive to the date: if the same deal slips to 400 days, the simple annualised spread halves to 3.80 percent, though the dollar spread has not changed.

The same numbers also show how the spread prices risk. If a break would send this target back to $38.00, a holder stands to gain $2.00 if the deal closes and lose $10.00 if it breaks. The two outcomes balance when the chance of closing is $10.00 / ($2.00 + $10.00) = 83.3 percent. That figure is arithmetic on a hypothetical, ignoring time value and dividends; it is not an estimate that any deal will close, and the price a target would fall to on a break is itself a guess.

The deal timeline, filing by filing

A US public-company merger leaves a trail in SEC filings, which is where a deal's terms and dates are recorded.

1. The agreement (Form 8-K, Item 1.01). Signing a merger agreement is entry into a material definitive agreement, which the target, and the buyer when the deal is material to it, report on Form 8-K within four business days. The 8-K summarises the price, the conditions, the termination fees and the outside date, the date after which either side may walk away, and attaches the agreement itself. How to read an 8-K covers the form. 2. The merger proxy (PREM14A, then DEFM14A). When the target's shareholders must vote, the target files a preliminary and then a definitive proxy statement describing the background of the deal, the fairness opinions and the terms. What a proxy statement is explains the Schedule 14A filing codes. 3. The registration statement (Form S-4). When the buyer pays in its own shares, it registers them, usually on Form S-4, which typically doubles as the proxy statement and prospectus sent to the target's holders. 4. Or a tender offer (Schedule TO). A buyer can instead offer to buy the shares directly. It files a Schedule TO, the target answers on Schedule 14D-9, and the offer must stay open for at least 20 business days. In Delaware, section 251(h) lets the buyer complete the merger after a successful tender without a separate shareholder vote, when the agreement provides for it and the target's shares are listed on an exchange or held by more than 2,000 holders of record. 5. Antitrust waiting period (Hart-Scott-Rodino). For deals above the size thresholds, both sides notify the FTC and the Justice Department and must wait 30 days, or 15 days for a cash tender offer, before closing. The agencies may end the wait early, or issue a request for more information (a second request), which extends the wait until 30 days after the parties have complied, or 10 days for a cash tender offer. 6. The vote. For a Delaware company, adopting a merger agreement requires a majority of the outstanding stock entitled to vote, not just of the shares voted, with notice sent at least 20 days before the meeting. 7. Closing (Form 8-K, Item 2.01). Completion of the acquisition is reported on Form 8-K, and the target's shares stop trading.

What happens when a deal breaks

A terminated agreement is reported on Form 8-K under Item 1.02, Termination of a Material Definitive Agreement. Merger agreements set out in advance who pays whom if that happens:

• A termination fee is paid by the target to the buyer in stated cases, such as when the target's board accepts a better offer.
• A reverse termination fee is paid by the buyer to the target in stated cases, such as a failure to obtain antitrust clearance or financing.

The fees can cover only part of the gap. The target's shareholders are left holding a stock that no longer has a deal price under it.

A real example: JetBlue and Spirit Airlines. On 28 July 2022 Spirit agreed to be acquired by JetBlue for $33.50 per share in cash, less prepayments JetBlue would make to Spirit's holders before closing: $2.50 per share once holders approved the deal, then $0.10 per share for each month after 2022 until closing, capped at $1.15. The 8-K set an outside date of 28 July 2023, extendable to 24 July 2024 if needed for regulatory approvals. It set a termination fee of $94.2 million payable by Spirit in specified circumstances, and, if the agreement were ended for failure to obtain antitrust clearance, a payment by JetBlue of $70.0 million to Spirit and, to Spirit's holders, $400.0 million less the prepayments already paid to them.

Spirit's holders adopted the agreement at a special meeting on 19 October 2022. On 16 January 2024 the US District Court for the District of Massachusetts granted the Justice Department's request for a permanent injunction against the merger, as Spirit reported on Form 8-K. On 4 March 2024 Spirit reported, under Item 1.02, that the merger agreement had been terminated under a termination agreement under which JetBlue would pay $69 million in cash to Spirit.

Collars in stock deals

A fixed exchange ratio leaves the target's holders exposed to the acquirer's price all the way to closing. A collar limits that exposure, within a band.

Fixed-value collar (floating ratio). The target's holders receive a fixed dollar value in acquirer shares as long as the acquirer's price stays within a band; the ratio floats to deliver it. Outside the band, the ratio stops moving and the value moves again. A hypothetical with a $40.00 value and a band of $72.00 to $88.00 for the acquirer:

Fixed-ratio collar. The reverse: the ratio is fixed while the acquirer trades inside a band, so the value moves with the acquirer's price, and outside the band the ratio adjusts to keep the value from moving further.

The acquirer price that sets the ratio is usually an average over a stated measurement period shortly before closing, not the price on any one day, and the agreement may give one side a right to walk away if the price moves past a further limit. The collar terms are in the merger agreement attached to the 8-K and are restated in the proxy or S-4. For anyone measuring the spread, a collar means the deal value is not simply the ratio times today's acquirer price; it has to be read off the collar schedule.

Where Kresmion shows deal spreads

Kresmion's public merger arbitrage board, free with no account, lists pending deals found in SEC filings whose target's shares trade, excluding partial tender offers and SPAC combinations, with each deal's terms read by a parser from its SEC filings: the cash price or exchange ratio, the termination fee and reverse termination fee where the filing states them, the close period the filing names and the outside date. From those terms it computes the spread, a simple annualised spread to the last day of the stated close period (only when that day is at least a week away), and the premium against the target's close on the last session before the announcement. A contingent value right is not valued, and a deal that lets holders elect cash or stock gets no spread. Where a prediction market prices the deal's completion, the board shows that price with its source, and for targets in Kresmion's options universe it can show the risk-neutral probability that the target trades near the deal value at expiry, which is not a real-world probability; Kresmion itself puts no probability on any deal closing. The share prices behind each spread need a free account. What a prediction market is explains how those completion prices are formed.

Honest limitations

A spread is computed from a last price and a deal value, and both move. The board's terms come from an automated reading of filings, which can miss a term, misread a party or lag a change, so the filing remains the record. Annualised figures depend on a closing date that the filing states as a period, not a promise, and deals often close earlier or later. A collar, a contingent value right, an election or a dividend changes the deal value in ways a single spread number does not show. Merger arbitrage is described here as a way of reading a deal's price; nothing on this page says whether a given deal will close or what anyone should do about it. The hypothetical figures are illustrations; the Spirit and JetBlue figures are from their SEC filings dated 28 July 2022 to 4 March 2024.

Key takeaways

Frequently asked questions

Is merger arbitrage risk-free?

No. The spread exists because the deal can fail, be delayed or be renegotiated, and when a deal breaks the target's price can fall by many times the spread. The JetBlue and Spirit agreement, adopted by Spirit's holders in 2022, was blocked by a federal court in 2024 and terminated.

Why does a target trade below the offer price?

Because the deal is not certain, because the money is tied up until closing, and because conditions such as antitrust clearance and the shareholder vote are still outstanding. The gap, the deal spread, is the market's price for those risks and that time.

Why would a target trade above the offer price?

A negative spread usually means the market is pricing some chance of a higher offer, from the same buyer or a competing one. It can also reflect a dividend or other payment holders receive before closing that is not part of the headline price.

What is a reverse termination fee?

A payment the buyer makes to the target if the deal fails for stated reasons, commonly a failure to obtain antitrust clearance or financing. It is set out in the merger agreement, summarised in the 8-K that announces the deal.

How is the annualised spread calculated?

The simple version multiplies the spread by 365 and divides by the days left to the expected closing: a $2.00 spread on $48.00 with 200 days to go is about 7.6 percent a year. A compounded version gives 7.73 percent. Both depend on a closing date that can move.

What is a collar in a merger?

A clause in a stock deal that limits how far the value received, or the number of shares issued, can move with the acquirer's price, within a stated band. Outside the band the protection stops and the value moves again.

This page is information, not investment advice.

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Source: Spirit Airlines, Inc., Form 8-K filed 28 July 2022 (Items 1.01 and 1.02, merger agreement with JetBlue Airways), https://www.sec.gov/Archives/edgar/data/1498710/000119312522204192/d368049d8k.htm ; Spirit Airlines, Form 8-K filed 20 October 2022 (Item 5.07, special meeting of 19 October 2022), https://www.sec.gov/Archives/edgar/data/1498710/000149871022000343/save-20221020.htm ; Spirit Airlines, Form 8-K filed 19 January 2024 (Item 8.01, court injunction of 16 January 2024), https://www.sec.gov/Archives/edgar/data/1498710/000149871024000045/save-20240116.htm ; Spirit Airlines, Form 8-K filed 4 March 2024 (Item 1.02, termination), https://www.sec.gov/Archives/edgar/data/1498710/000149871024000124/save-20240301.htm ; Form 8-K General Instructions (four business days; Items 1.01, 1.02, 2.01), https://www.sec.gov/files/form8-k.pdf ; Form S-4, Rule as to Use of Form, https://www.sec.gov/files/forms-4.pdf ; Rule 14e-1, 17 CFR 240.14e-1, https://www.ecfr.gov/current/title-17/section-240.14e-1 ; Hart-Scott-Rodino Antitrust Improvements Act, 15 U.S.C. 18a, https://www.law.cornell.edu/uscode/text/15/18a ; FTC, Premerger Notification Program, https://www.ftc.gov/enforcement/premerger-notification-program ; Delaware General Corporation Law, section 251, https://delcode.delaware.gov/title8/c001/sc09/index.html ; worked spread, annualisation and collar examples: hypothetical figures computed by Kresmion ; Kresmion merger arbitrage board (SEC filings).

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