Introduction General Electric Company (GE) proposed a bid for Honeywell International Inc (Honeywell) . GE is one of the largest and most diversified corporations, which generate revenues in segments as diverse as aircraft engines, plastics, and financial services. Honeywell is a diversified technology and manufacturing corporation leading in certain aerospace markets. It specializes in segments that include aerospace products and services, power generation systems and specialty chemicals.
Honeywell’s main group of businesses is a perfect fit for GE’s major businesses (Aircraft Engines, Industrial Systems, Plastics, and Power Systems). GE’s operating systems and social architecture, together with companies’ common structure also match together. GE formally announced the deal on October 22, 2000; in which GE offered 1. 055 GE shares for each share of Honeywell, plus assumed dept. The company submitted the required regulatory fillings to the U. S. Department of Justice (DOJ) and notified the European Commission (EC) of the proposed merger.
Antitrust regulatory authority of EC announced that it had initiated the review of the proposed merger. There are potential complications that might jeopardize this deal, mainly antitrust concerns in both United States and European Union, and additionally protectionist policies in the EU that would oppose increasing the power of major American firms. Bancroft’s Capital Management is an arbitrage fund with long arbitrage position by fund’s 10 million shares in Honeywell and its short position of 10 million shares in GE, with 70 % invested capital borrowed at 15 % interest .
It’s necessary to decide wheatear it will sell or maintain its position in this companies, taking into account possible outcomes of EC investigation of the deal. Statement of Goals. In order to analyze Bancroft’s Capital Management decision whether to hold or sell its fund’s 10 million shares in Honeywell and its short position of 10 million shares in GE, we will: • assess the probability that the merger would be approved by antitrust regulators in the United States and Europe • estimate ROI on risk arbitrage position, which include net spread calculation of Bancroft
• analyze through sensitivity analysis how Return on Investment for Bancroft’s shares will be influenced by fluctuating stock price caused by announced merger • investigate through sensitivity analysis how holding period will effect Bancroft’s Return on Investment Assumptions In order to make adequate decision whether Bancroft should sell or hold their shares in GE and Honeywell companies, following assumptions are used in estimation of ROI risk arbitrage position and sensitivity analysis : [pic]
• Value of target shares (Honeywell) at end of holding period on July 1, 2001 is $ 42. 1 • Value of buyer shares( GE) at end of holding period on July 1, 2001 is $ 41. 00 • Bancroft has 70 % invested capital borrowed at 15 % interest Findings and discussion In this case, it is possible that procedural differences between the DOJ and the EC affect respective decision analysis of the Bancroft’s Capital Management. On March 1, 2001, the European Commission made its unexpected decision and open a full time investigation into the proposed GE- Honeywell transaction.
The EC decision destroy GE plans to complete the merger deal by end of March or April and postponed it to July 1, 2001. This fact has a negative impact on perception of shareholders on created synergy value of the merger. The synergy value that was either there or was created by stockholders expectations of the proposed GE-Honeywell combination (which was suppose to become dominating company in aerospace business) in time from October 20,2000 until March 1 , 2001 will decrease or diminish in period from March 1 , 2001 until July 1, 20001.
Postponing of the merger create a negative perception about the merger, and also make stockholders doubt this acquisition, which will cause the synergy value of combination of these 2 companies to decrease. Since the value of the synergy is the present value of the cash flows created by it, the longer it takes it to show up, the lesser it is the value. At this point, it is less likely that this merger will occur; therefore, we can see shifting of the stock prices of both companies towards their original price before the attempt of the merger occurred.
GE prices are increasing therefore assumed price in July 1, 2001 will be $ 43, and Honeywell stock prices assume to decline to $ 41. 3 in July 1, 2001. We calculated Bancroft’s annualized return on capital during period October 20, 2000 to March 1, 2001 (holding period of 132 days) which was 99. 72 %. For period after the EC announced the full time investigation of GE-Honeywell acquisition, the holding period was extended to 254 days (Until July 1,2001) and as a result annualized rate on return declined to 30. 98 %.
From Sensitivity analysis of 254 day Return on Capital on Honeywell stock price we can observe that simultaneously with decreasing stock price of Honeywell, Return on Capital for this holding period is also decreasing. From Sensitivity analysis of 254 day Return on Capital on GE stock price, we can see that with increasing stock price of GE, return on Capital for 254 day holding period is decreasing and will show negative numbers as soon as stock price will reach 46 $.
In a case that stock prices of both companies will fully recover to their original value will not capture any return on capital, but also will suffer additional loss that will occur from her interest expense of 15 % on the borrowed capital with which she purchased the Honeywell shares. Also holding period greatly influences Bancroft’s Return on Capital. By cutting the holding period, we can increase our Return on Capital. We can apply this theory to our sensitivity analysis by changing the holding period number in our estimation of ROI on risk -arbitrage position.
Conclusion In conclusion, Bancroft’s Capital Management should sell its fund’s 10 million shares in Honeywell and its short position of 10 million shares in GE. After postponing the GE-Honeywell acquisition due to the further investigation of EC of this merger, probability that this merger will actually occur is decreasing. Therefore, we assume that merger will not occur and stock prices of GE and Honeywell will eventually recover to their stock price before the deal between these 2 companies was announced in October 20 , 2000.
Increasing GE stock price, as well as decreasing Honeywell stock price has negative effect on annualized return on capital. Increasing holding period of shares, which incur due to EC investigations of this acquisition, also decrease Bancroft’s annualized return on capital. Taking into consideration all facts mentioned above, it is recommended that Bancroft’s Capital Management should liquidate their 10 million shares in Honeywell and its short position of 10 million shares in GE.