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Handling Derivatives and Reference Prices in a Merger With Spin-Offs

Article Quant Q&A · Author: CuriousMind
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Summary

The document considers how to establish reference values when a merger is combined with spin-offs. Its example involves the creation of a merged company alongside separately listed spin-off companies. The question proposes valuing the merged company from the predecessor firms’ market capitalizations, then subtracting the spin-offs, and asks how to value the new shares, including whether when-issued prices should be used.

The answer does not provide a market-cap calculation or a pricing formula. Instead, it points to the role of contractual and exchange rules in determining how derivatives are adjusted or settled after corporate actions, noting that counterparties and exchanges may have procedures for mergers. It cites an exchange’s corporate-action procedures as an example. The note is useful for understanding where to look when assessing derivative treatment, but it leaves open how index providers set constituent weights and how specific when-issued prices feed into a reference value.

Key ideas

  • A merger with spin-offs creates separate securities whose reference values may need to be considered.
  • Derivative treatment after corporate actions is generally governed by agreements or exchange rules.
  • Exchange procedures can specify adjustments for mergers and other corporate actions.
  • The note does not provide a formula for valuing the spin-offs or setting index weights.

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EquitiesOptionsEvent-driven
Full text
# How to price complex corporate actions with spinoffs


# How to price complex corporate actions with spinoffs












Let's look at below UTX/RTN merger as an example:

https://www.fool.com/investing/2020/03/30/raytheon-united-technologies-merger-gets-green-lig.aspx

> The merged companies will from that moment forward be known as Raytheon Technologies Corporation, and the stock of this new, merged entity will trade as ticker symbol "RTX" on the NYSE. To effect the merger, each outstanding share of Raytheon Company will be converted into 2.3348 shares of Raytheon Technologies Corporation. Each outstanding share of United Technologies will simply be renamed as a share of Raytheon Technologies Corporation. United Technologies Chairman and CEO Greg Hayes will lead the new company. Immediately after the merger, Otis will spin off as a new NYSE-listed company under the ticker symbol "OTIS;" Carrier will similarly spin off and trade as "CARR," also on the NYSE. Each share of United Technologies that a shareholder owned on Thursday will become a separate share of Carrier and a separate 0.5 share of Otis on Friday.

I am trying to understand what the "fair price"(or more like a "reference price") of RTX should be after this complex corporate action. I understand the "fair price" here is a bit vague, but I imagine the street has to agree on some sort of pricing for various derivatives or indexes. For example, UTX is a Dow Jones constituent, so index provider has to consider the proper prices of RTX when re-balancing the index weights. Options exchange has to convert/settle the UTX options into RTX options somehow, etc, etc.

So the way I understand is, the market cap of RTX right after UTX and RTN merge, is just the sum of RTN and UTX. Then you have to subtract the market cap of CARR and OTIS. The number of shares of RTX should just be number of shares of UTX + 2.3348 * number of shares of RTN.

But then, how do you determine the "market cap" of OTIS, and CARR? There are when-issued trading for OTIS and CARR, but does the capital market really rely on the last-close of WI to determine their market caps?

Would appreciate any input.

## Answer by Kermittfrog (score 1)

https://quant.stackexchange.com/a/53018

For derivatives, there usually exists some agreement between the counterparties on how to handle corporate actions. The same for exchange traded contracts. EUREX, for example, has some pieces on the treatment of corporate actions and also mergers, here:

https://www.eurexchange.com/exchange-en/products/equ/corporate-actions-procedures

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.