BNI-BRK: The Option Market Implies Pro-ration

Discussion in 'Trading' started by livevol_ophir, Feb 10, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    Here is a quick summary of the takeover - analysis and discussion to follow:
    Burlington Northern Santa Fe Corp shareholders will receive $100 per share in cash and stock from Berkshire Hathaway Inc.(BRK-B). BNI Shareholders have the option to convert their stock for a cash payment of $100 per share or receive Berkshire Class A or Class B common stock. This is subject to proration if the elections do not equal approximately 60% in cash and 40% in stock. The stock is subject to a collar whereby the value fo each Berkshire Hathaway share received is fixed at $100.00 if the price of Berkshire Hathaway Class A stock at closing is between approximately $80K and $125K per share. A stock will be fixed at either 0.001253489 per BNI share for values below the collar range, or 0.000802233 per BNI share for values above the collar range. The value of the deal is about $44 billion.

    I believe the 10 day pricing period ends today - the ratio of BRK.A shares that each BNI shareholder gets will be $100/{10 day average of the VWAP of BRK-A}.

    The actual conversion to stock BNI --> BRK.A is ~ 16th; The deal closes the 12th and BNI ceases to exist. Adding a little more complexity, BNI has a dividend of 0.26 receivable upon closing of the merger.

    The BNI options Tab snapshot is included in the article. The BRK.B (1 BRK.A = 1500 BRK.B) Options Tab snapshot is included as well.

    We can find what the market is implying about the pro-ration from the option markets. IV30&#8482 for BRK.B is 35 (see below). Hypothetically 1 BNI share could be 60%*$100 and 40%*(something with volatility). See the summary in article.

    So if BNI 100 calls are worth ~0.55 (from options tab above), and that is a weighted average of:
    (1) 0.26 (don't forget the dividend!)
    (2) 100 strike call with 35 vol = 2.32

    So the market is implying: 0.86*$0.26 + 0.14*$2.32 = 0.55 (i.e. 86% cash payout).

    If you ignore the dividend, then the pro-ration indicated by the market is:
    0.24*$2.32 + 0.76*$0.00 = $0.55 (i.e. 76% cash payout).

    Finally, the BNI skew chart is included. Interesting that there is still a "real" skew when BNI may go away in 2 days.

    <b>Skew Legend</b>
    Red - Front
    Yellow - Second
    Green - Third
    Blue - Fourth

    Please note these are all approximations (including the dividend - which in and of itself is a separate analysis). This is not trade recommendations (I leave the trading to you), just analysis.

    Details, prices, snapshots on blog here:
  2. sounds too complicated to make money.
  3. Does the deal close at the end of the day on the 12th, or at the open?
  4. livevol_ophir

    livevol_ophir ET Sponsor

    My best guess is that BNI does not open as a stock on 12th (open).
  5. But, technically, it's still undecided?
  6. livevol_ophir

    livevol_ophir ET Sponsor

    Nothing is certain in these deals. The price of BNI is essentially the cash price; so it looks "relatively" certain; but you are right - it is not for sure.