Background
A modified Dutch auction tender offer occurs when the company wants to
repurchase its shares. Instead of buying the stock on the open market or acquiring
them in a private transaction, the company wants to make a statement. The statement
may be that they feel the stock is undervalued,
that they wish to return excess cash to shareholders, or that they want to reduce
the number of outstanding shares, number
of shareholders, or both. They offer to buy a specific number of shares within a
price range, usually at a premium to the
current price.
For example, the Tribune Company announced on May 30, 2006 that it would buy
back 53 million shares at a price between 28 and 32.50, expiring on June
26. The day before the announcement, the stock closed at 27.89. The offer
represented a buy back of 17.5% of the outstanding
shares of the company (a large buyback). After completion of the auction, the
company bought all of the tendered shares, 45,026,835,
at a price of 32.50. A little over two weeks after completion of the tender offer,
the stock started sliding and it bottomed
at 28.50 before rebounding (a V-shaped decline).
Analysis
I looked at all the Dutch auctions for stock I could find in the recent past,
using Google. In the 50 transactions I uncovered (which I consider to
be a small sample, so the statistics may be unreliable), the earliest was in
January 2000, and the most recent was in July 2006. I excluded some transactions
because they were too recent (not enough follow-on price data), and removed many
because they no longer traded (unavailable price data).
Findings
- The median buyback was for 17.1% of shares outstanding. Comparing the closing
price the day the offer expired with the highest price over the next 3 months, I
found that small buybacks (less than the median 17.1% of shares outstanding)
had price peaking 13%. Large buybacks (buying back more than the median 17.1%
of shares outstanding) saw price rise 9.1%.
Substituting the lowest price in the next 3 months for the highest, I found small
buybacks had price peaking 7.4% above the
expiration day’s close. Large buybacks saw price decline 12.8%. In short,
companies that repurchase less of their stock
perform better in the 3 months after the tender ends.
- In 65% of the cases, price closed below the tender price at the expiration of
the auction.
- At least once during the three months after completion of the auction, 96% of
the stocks closed below the tender price. The median decline was 10%, the average:
11%, with 60% of the stocks dropping at least 10% below the tender price.
- The largest number of stocks (26%) bottomed in weeks 3 and 4 after auction
completion.
- Just 29% of the auctions had price above the tender offer at the end of one
month, 40% showed a higher price at the end of 2 months, and 47% had a higher price
at the end of 3 months.
- Price climbed above the tender price 77% of the time over the 3 months after
the auction completed, peaking 13.8% above the tender price.
Trading
Step 1. Tender your shares because price is going
to drop after the offer expires (96% close lower sometime over the coming 3 months,
with a median drop of 10%). This is especially true if the buyback is large (above
the median 17.1% of shares outstanding). Tender offers with that criteria tend to
make V-shaped moves after the auction completes.
If you decide to tender your shares, at what price should you
tender? If you measure the offered price range and take 25% of that range below the
high, that would work 70% of the time. In the Tribune Company example, the offered
range is 28 to 32.50, for a spread of 4.50. A quarter (25%) of this is 1.13, so a
bid placed at 32.50 – 1.13 or 31.37 would succeed 70% of the time.
Other percentages: 10% below the high (meaning 10% of the offering price range,
subtracted from the range high) works 54% of the time.
20% below the high works 62% of the time.
45% below the high works 76% of the time.
50% below the high (midway in the offering price range) works 80% of the time.
70% below the high works 88% of the time.
I recommend the 25% target price, which works more than two of every three
trades.
Step 2. Buy the stock back when it declines. Many
will see price bottom in weeks
3 or 4 after the offer completes, but don’t depend on this.
Step 3. In the three months after the auction
completes, 38% of the time price
makes a new high after it reaches the low. If you buy at the low and sell
at the high, you would make an average of 26.8%. But, you might just want to hold
onto the stock for additional fun and gains.
Patterns
The above figure shows four patterns price takes after the auction completes. In
the upper left, price makes a V-shaped move, meaning it declines before
recovering. This pattern occurs 74% of the time when the buyback is above the
median 17.1% of shares outstanding (a “large
buyback”).
The inverted-V shape in the upper right of the figure occurs 68% of the time in
small buybacks.
The bottom two patterns rarely occur. I found the one on the bottom left in only
5 of 50 takeovers. Sixty percent of the time, it occurred after a large
buyback.
The bottom right occurs in only 4 of 50 auctions and most often (75% of the time)
the buyback is small.
In all cases, the 50 auctions are a limited sample, so use your best judgment
when trading this event pattern.
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