Theo Vermaelen, Share repurchases can be a good deal, FT Oct 19 2006 From being a rather obscure, mainly US activity, share repurchases have become an important global transaction. Since 2000, the number of share repurchase announcements made by non-US companies is at least as large as it is in the US. The total global US dollar volume of buyback activity reached its peak in 2005, at approximately $400bn, although the number of repurchase announcements was much larger in the late 1990s.
The increase in repurchase activity outside the US is the result of factors such as deregulation, tax changes, increased concern about shareholder value and the adoption of stock option plans. Share repurchases used to be illegal in many countries or were discouraged using tax laws. Moreover, managers typically prefer to use excess cash to grow and expand, rather than return it to shareholders. Finally, a repurchase can be used to minimise the dilution created by executive stock option compensation. Share repurchase methods: A company can repurchase shares in four different ways: a fixed-price tender offer; a Dutch auction tender offer; a repurchase in the open market; and a privately negotiated repurchase from a large investor. ■ Fixed-price tender offer This is when a company offers to repurchase a specific number of shares at a given price (the tender price) before a given date (the expiration date). For example, on July 5, Prepaid Legal Services announced a fixed-price tender offer for 1m shares at $35 per share. The offer expired on August 2, so investors had about one month to decide whether to tender their shares. However, because the stock price rose to $35 after the announcement, only 166,960 shares were tendered. It seems that the market believed that the company was trying to buy back stock cheap. As a result, most investors did not tender. This may have been a consequence of the fact that the tender price was only 5 per cent above the market price prior to the repurchase, which is far below the typical premium of 22 per cent reported by various researchers.
This highlights some of the problems with fixed-price tender offers: if the tender price is below or equal to the market value after the repurchase announcement, the offer will be unsuccessful. If, however, the tender price is significantly higher than market value, the offer will be heavily oversubscribed, and the company may feel it has paid too much.
■ Dutch auction tender offer In this case, the company specifies a range of prices within which each tendering shareholder chooses their minimum acceptable selling price. Dutch auctions can be more appealing to a corporation than a fixed-price tender offer. There are several reasons for this: it is a cheaper way to buy back a specific number of shares than a fixed-price offer; you are essentially repurchasing from the most pessimistic investors, who would be the first to sell the company to a hostile bidder; and the repurchase price is not fixed in advance, but moves with the general level of the stock market, which means the company is better hedged against stock market crashes.
On July 20, Microsoft announced a Dutch auction tender offer to buy back about 808m shares for a price per share no greater than $24.75 and no less than $22.50.
Each shareholder then informed the company of the number of shares he was willing to sell and the minimum acceptable selling price. The company then pays to all stockholders the lowest price that will secure the number of shares sought. However, on the expiration of Microsoft's offer, on August 17, only 155m of the 808m shares sought were tendered and the company had to pay the top price of the price range ($24.75). So, even a Dutch auction failed to pay off as planned. ■ Repurchase of shares on the open market If the company is not in a hurry to repurchase a lot of stock, wants to preserve flexibility and does not want to pay a premium above the market price, it can repurchase shares...
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