AYE Merger with FE, Arbitrage in Play?

K

KAWill70

FirstEnergy intends to buy Allegheny Energy and the approvals are moving along. Each share of AYE would become 0.667 shares of FE.

When announced in February, AYE increased in price 12% while FE fell 4.5%. AYE then showed a premium of 15% relative to FE, and the premium has steadily fallen to about 1.5% today as the merger looks more certain. The two stocks are now moving in lock step.

Three questions:

1. If the merger falls through, would you expect AYE to fall and FE to rise?

2. Is Arbitrage in play where investors are buying AYE and shorting FE? The NASDAQ website shows considerable short interest in FE.

http://www.nasdaq.com/aspxcontent/shortinterests.aspx?symbol=FE&symbol=AYE&selected=FE

3. What would you expect if the merger completes? Would there be a lot of short covering in FE resulting in a rise in price?

Thanks any for thoughts.

KAWill70
 
1. Yes. Mainly due to the unwinding of the arb positions. (currently long AYE, short FE)

2.Yes, that is arbitrage.

3. No. There would not be any short covering. Your positions cancel out based on the exchange ratio announced in the deal. You don't sell you long AYE or cover your short FE.

Hope that helps.
 
Thanks for the help.

That makes sense now that I think about it assuming the investor retains the Long AYE and Short FE positions. AYE disappears and is replaced with 0.667 shares of FE for each share of AYE. That would offset the short position assuming the investor bought and sold shares at the correct ratio.

However, I wonder if some investors close out earlier. That case does not appear significant since others will maintain the price relationship of the two stocks.

I held AYE in December and sold to capture a tax loss. FE was purchased to maintain the dividend income, which will actually be more than twice as high. I did pay a small premium relative to waiting for the merger to complete. Maybe the premium is worth it since the merger may not complete, and I also receive the higher dividend.
 
I should make one correction. AYE is at a discount relative to FE and not a premium.

I was thinking in terms of FE relative to AYE. The percentages quoted are correct if considered a discount. I believe successful arbitrage in this case would require AYE to be at a small discount relative to FE. As a result, the short sale of FE would be a higher dollar amount than the purchase of AYE.

KAWill70
 
I saw this play too at
<a target="_new" href="http://eb734kqj12wbiodiuivct52qbn.hop.clickbank.net/">mergerinvesting.com</a>
is this where you saw it too? this is the only source or merger arb signals i know of, is there any others?
 
I only knew about the merger because I had held AYE for a number of years.

Perhaps others can comment on sources for all the various pending mergers.

There are a couple mutual funds that get into this area. Take a look at MERFX and ARBFX.

By the way, I noted above that AYE jumped 12% when the merger was announced. That is why I suggested that it could drop if the merger falls through.
 
More utility stocks were in the news this week including another one of my holdings.

Progress Energy (PGN) was up quite a bit over the last two days. There is nothing confirmed but the news suggests that Duke Energy (DUK) might be interested in acquiring PGN.

Both companies have dividend yields over 5.5%.
 
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