Evaluating Conditions and Terms of the AT&T and DirecTV Merger

On May 18, 2014, AT&T Inc., the second-biggest U.S. mobile-phone carrier, agreed to acquire DirecTV, a satellite-television company, for $49 billion in cash and stock. However, the merger’s conditions and terms are complicated as the stock exchange ratio is contingent on the volume-weighted average AT&T stock price over a 30-day period that is three trading days prior to the date when the merger becomes effective. Using a contingent claims pricing approach, we model DirecTV’s theoretical value based on the merger’s conditions and terms. It is shown that the theoretical DirecTV stock value is analogous to the sum of the present value of a cash offer, plus owning shares of the AT&T stock, and short volume-weighted average price (VWAP) call spreads. Using three different option-pricing models, DirecTV’s stock valuation model is tested with the market data. Empirical results show that on average, DirecTV’s stock was consistently priced at a discount during the sample period, and Funahashi and Kijima’s (2017) VWAP option model works better than Black and Scholes’ (1973) plain vanilla option model and Levy’s (1992) average-price option model.