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Why Staples Will Increase Its Offer for Corporate Express
Imagine
you go to a casino and spot a big bucket filled with 100 balls. There
are 51 red balls and 49 blue balls. Next to the bucket there is a sign
which informs you that you can guess the color of a randomly drawn ball
for $1. If you are right, you will receive $2, but if you are wrong you
will lose your bet. A rational investor will take a seat next to this
bucket and will not leave anymore. By consistently betting on a red
ball being drawn, he can calculate a 51% chance of achieving a return
of $2 and a 49% chance of a return of $0, which gives an expected
return of $1.02 for an investment of $1.We can apply the
methodology of this simple probability calculation to determine what
the expected value of the acquisition by Staples (SPLS) of Corporate
Express (CXP) will be. In this case, there are a couple of
complications and we need to make some extra assumptions to make this
calculation.The easy part is determining the value of the bet, which is
equal to the actual stock price of Corporate Express. At the time of
writing, this was about 7.80 Euro, a premium of 7.5% in comparison with
the offer from Staples of 7.25 Euro. Subsequently, we can calculate how
much a rational investor wants to receive when the acquisition is
finalized. I assume closing of the acquisition will not take place
before the end of May, which means that Corporate Express shareholders
will have received a dividend of 0.21 Euro before this closing. The
rational investor, who is only concerned with probability calculations,
will expect to receive at least an amount of approximately 7.87 Euro at
the end of May, assuming an interest rate for short term deposits of
4%. At the end of April, he will already have received 0.21 Euro, which
implies that the remainder of 7.66 Euro has to come from his bet on the
outcome of the draw from the bucket of balls.We still need to
determine the probability of the outcomes and the values of the
outcomes of the draw. Since Corporate Express was trading in a range of
5.00 – 5.50 Euro before the offer from Staples, I assume the share
price could drop to 5.00 Euro again, if the acquisition fails to take
place. I assign this outcome a probability of 20%. We still don’t know
the value of a successful offer, but we do know that the rational
investor wishes to receive at least 7.66 Euro. Knowing this, we can
calculate the value of the expected offer, which has a chance of 80%.
The calculation is (7.66 – (0.20 x 5)) / 0.80 = 8.33. With this offer
price, an investor has a chance of 20% to receive 5 .00 Euro, and a
chance of 80% to receive 8.33 Euro. This gives an expected return of
7.66 Euro, exactly his minimum requirement. Including dividend, the
offer would have to be 8.54 Euro.If we would assign a chance of
70% to a successful offer, the acquisition price would need to be 9.02
Euro, while an expected chance of 90% of success gives an acquisition
price of 8.17 Euro.The conclusion is that the rational calculating
investor, who is presently considering taking a position in Corporate
Express for a price of 7.80 Euro, and who assigns a 80% chance of
success for the acquisition to take place, expects a final offer of
8.54 Euro, including dividend. If the offer fails, this investor will
expect the share price could drop back to 5.00 Euro.I believe that most
current shareholders of Corporate Express are rational calculating
investors, and that they believe a revised offer needs to be at least
somewhere in the 8-9 Euro range to be successful. If Staples is serious
about its intentions to acquire Corporate Express, it is hard to
imagine that they would not have expected that an increased offer would
be required. If this is the case, the indicated range should not come
as a surprise either.
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