Zynga Inc (NASDAQ: ZNGA) stock has jumped 45% premarket this morning on the news of the takeout offer from Take-Two Interactive Software (NASDAQ: TTWO). The intention is to blend the two leading mobile game makers into an industry powerhouse. Add the maker of Farmville to Take-Two’s portfolio and perhaps that will really happen too.
However, the question for us as traders is, well, if the takeover offer is at a 64% premium to Friday’s closing price then why has the stock of Zynga only risen 45% today? Is there money being left on the table there that we can pick up risk-free?
This whole process is called arbitrage – picking up a risk-free profit that is – and Zynga and Take-Two offer an interesting example of how it works.
The thing to understand here is that it’s not a wholly cash offer. Instead, the terms are “Zynga stockholders will receive $3.50 in cash and $6.361 in shares of Take-Two common stock for each share of Zynga common stock”. If we take those stock prices of last Friday then that does amount to the 64% premium to the Zynga stock price. But note the important thing – that depends upon the Take-Two stock price remaining elevated.
This isn’t what happens in a takeover. Take-Two will issue more stock to pay for Zynga. Therefore today – or soon enough – there’s going to be much more Take-Two stock around than there was on Friday. Increase supply, see a fall in price, that’s right there on the opening page of every college economics book, we get that.
We can also be a little more experienced, or worldly-wise, and note that the average stock market takeover makes money for the stockholders of the company acquired and loses it for those of the company doing the acquiring. Sure, everyone thinks this bid will be different but that is the way it usually works out. Zynga stockholders will make money here, Take-Two stockholders will lose – or at least that’s the way to bet.
So, on the announcement of a takeover the trading strategy is to go short the bidder, long the target. If that’s done swiftly enough then that locks in the profit – creates an arbitrage position – from the takeover. Short Take-Two and long Zynga.
If this is all well known as a tactic, which it is, then this is what in itself produces the stock price movements we are seeing. Zynga stock jumps, Take-Two stock falls as those arbitrages are put in place. That’s also why the Zynga price jumps by less than the premium above Friday’s prices, as part of the deal is in Take-Two stock which has just lost value as a result of the bid itself.
There’s nothing very odd about this, that’s just the way it generally does work out. Take-Two stock falls in value as Zynga’s rises, that’s just how stock market takeover bids usually work.
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Tim Worstall is a freelance writer specialising in economics and the financial markets.