“Before figuring out how you will win the game, figure out which game to play.”
– Michael Maubossuin
In the traditional analytical framework of investing, a share of stock is valued as the net present value of all the free cash flow of a firm (based on an appropriate discount rate) divided by the total number of shares outstanding. Now, that is all fine and dandy, but from a pragmatic perspective, there are only so many ways that a company can return actual cold, hard cash to its shareholders. Besides dividends, another common, albeit less well-known method is the share buyback. A share buyback, also known as a “share repurchase”, is the act of a company buying back shares of its stock in the market. Because a company cannot legally be its own shareholder (as fellow Excel nerds know, that would be the mother of all circular references), repurchased shares are either cancelled or held on the sidelines as treasury stock. The number of outstanding shares available to the market is reduced, and as such, the ownership stake of each investor increases. Typically, buybacks are carried in one of two ways: via a Tender Offer, or via Open Market repurchases. The focus of this article will be on the Tender Offer.
In a typical tender offer, shareholders are presented with some information (via SEC filing SC TO-I) about the company’s intent to buy back shares. In the most basic form of a tender offer, a company will lay out:
- The number of shares to be purchased
- The price at which it will purchase the shares (“Purchase Price”, usually at a premium to the current market price)
- When the purchase period will end (Expiration Date, which is usually a month or so after first announcement)
An example of the disclosures for a typical tender offer can be found in here:
From a company’s perspective, a buyback via tender offer can be considered the best use of capital at a point in time, as it allows a company to repurchase a predetermined value of shares in a relatively short amount of time. From an investor’s perspective, tender offers sometimes offer uniquely attractive opportunities to earn a high rate of return with limited downside risk.
Before I dive into a case study of a recent plain vanilla cash tender offer, I want to highlight some of the typical conditions that I look for in evaluating a tender offer as an investment opportunity.
Show me the money – The first, and often most important, question: how is the company going to pay for the tender offer? Does the company have the necessary cash on hand to pay for everything, or does it need to borrow money to finance the transaction (i.e. is the offer subject to financing)? Having a financing condition indicates that the company would need to take out bank loans or issue other forms of debt and increase the leverage of the company to pay for the shares. This would be a significant point of concern, as the inability to obtain financing means a tender offer can fail before completion. Furthermore, even if there are no financing conditions, one still needs to do due diligence on the feasibility of the tender offer relative to the financial well-being of the company (i.e. whether the company still has enough cash to cover day-to-day operations after the tender is done).
Show me the players – Do a certain number of shares need to be tendered for the company to consummate the offer? If yes, then this condition could potentially reduce the likelihood of the offering being completed. In other words, if you tender your shares, you’ll need a sufficient number of other shareholders to share your point of view and tender their shares as well for everybody to benefit. That is not something you can control.
Odd Man Skips the Line – Typically, tender offers are oversubscribed. In other words, more shares will be tendered by shareholders than the maximum number of shares to be bought back by the company. In this case, only a certain portion of your tendered shares will be purchased by the company, and the remainder will be retained by you (this is known as proration). For example, if the company is willing to buy back 1,000,000 shares, and 2,000,000 shares are submitted by the shareholders, then only 50% of each shareholder’s submitted shares are bought back (i.e. the proration factor here is 50%). HOWEVER, if the tender offer documents contain an “odd-lot” provision, then holders of “odd-lots” will not be subject to proration. Typically, this means shareholders that own fewer than 100 shares. In other words, if you own 99 shares of a stock, and submit all your shares via a tender at the Purchase Price, all your shares will be purchased first before taking into consideration shareholders who own more than 99 shares. The plus side of this provision is that it if the tender is successful, it will likely result in a positive return on investment. The negative side of this provision is that the money you can put to work via 99 shares is often quite minuscule (as we shall see in the subsequent case study).
Guaranteed Delivery – Does the tender offer have a Guaranteed Delivery option? This is not high on the priority list, but typically a tender offer with guaranteed delivery will allow shareholders to submit purchased but not settled shares into the tender offer, subject to the stipulations and conditions of your broker-dealer. In other words, I can usually buy shares subject to tender offer on the morning of the Expiration Date and still submit the shares for tender by the afternoon.
Other Conditions – Most tender offers have certain conditions that will allow the company to delay or terminate the offer if the general markets (i.e. the Dow Jones Industrial Average, the S&P 500 Composite Index, or the NASDAQ Composite Index) falls by a certain percentage, usually 10% or so, during the time of the offer. If you look at the historical return profiles of the stock market, you’ll notice that >10% drops are extremely rare, but they do happen (e.g. late 2015 to early 2016), and tender offers have been terminated because of this reason in the past. Other conditions generally include but are not limited to: the initiation of major lawsuits against the company, the start or continuation of wars or armed hostilities, as well an initial filing of companies or investors accumulating more than 5% ownership of the company (via a 13-D or 13-G). The specific conditions are generally listed in the “Conditions of the Tender Offer” section of the SC TO-I, and I generally read through this section of the tender to offer to make sure that these conditions are generally acceptable to me before making an investment.
Case Study: WebMD
Summary: This as a simple and straight forward cash tender offer completed by WebMD in late 2016. The tender price was above the then current trading price of the stock, but it did not cause the price to increase dramatically, possibly because the tender offer was only for 5.2% of the shares outstanding. The source of funding was cash on hand, there were no minimum tender requirements, and there was an odd-lot provision. Investors could have made between 2% to 4% for holding WBMD anywhere between a week to a month, depending on the price you paid. A few things to note here:
1) Odd-lot participation in this tender offer was unusually high (45.8% of the shares purchased were odd-lots), which is atypical;
2) This offer is also unique in that the Purchase Price is set at a single number, $55, as opposed to a range of prices. We shall see next time other types of tenders where the Purchase Price is not set at a single number;
3) It is helpful to “watch the tape” in this case and follow daily stock movements, which is not something I would recommend for other types of investments. For example, an investor who demanded a minimum return of 4% could have waited and bought the shares on December 1st, 2016 and December 2nd, 2016, but that would have only been possible if an investor kept track of fluctuations in the stock price.
As you can see from the example above, cash tender offers are not what you would call “sexy” investments. They typically do not generate stupendous absolute returns, and they are not great topics of conversation for cocktail parties. However, they are unique opportunities that offer a differentiated and attractive risk-adjusted returns for the retail investor. Hopefully you are now familiar with the basic mechanics of a tender offer. Next time, in Part 2 of this 3-part series, we will be going Dutch and cover the most popular form of tender offer in the market today: The Modified Dutch Auction Tender Offer.
This article is provided for informational purposes and does not represent a recommendation to buy or sell any security. Please see full disclosures here.
