In December 2000 Pepsico (PEP – $45.8) proposed a merger with Quaker Oats (OAT - $87.7) in the value of $13 billion. If the deal will be completed, shareholders of OAT will receive in princiole 2.3 shares of PEP. But the offer is something more complicated. Depending on the price of PEP during the pricing period (six weeks before the deal closes) shareholders may receive a maximum of $105 (collar) if PEP is trading above $45.62 on randomly choosen ten trading days within the pricing period. If PEP trades below $ 40 shareholders of OAT have a right to renegotiate for receiving more than 2.3 shares of PEP.
OATs discount to the offer of PEP of
only a few percentage points during spring recently moved above 20% when the
watchdog FTC threatened to block the merger. The FTC argues that the combined
companies would dominate the sport drink market. OATs brand Gatorade has a
market share of 79% while PEPsicos
All-Sport drinks have a meager market share of 1.1%. It should be possible to
counter this objections as PEP already tried to sell this brand.
In summary there should be an even
chance that this merger will go through. If however it fails, there should be
enough interest in OAT by other bidders. The fair value of OAT without this
merger should be in the low 80s, so the risk seems to be limited.
Arbitrageurs do not like this deal
very much as it is difficult to hedge. Pepsico badly needs this acquisition for
growth reasons. So if the merger fails also the price of PEP may go down
somewhat. However as a hedge against general market risk one could sell short
PEP in a ratio of around 2:1. A final decision on the deal may be just 4 to 8
weeks away. In summary you should have a risk of less than 10% on a chance to
earn around 20%.
July 25th, 2001