Why do companies buy back their own stock?
When a company has surplus cash on hand there are several things they can do:
| 1. |
Make Acquisitions |
| 2. |
Investing in Research and Development for growth |
| 3. |
Pay (or increase) a dividend |
| 4. |
Buyback shares. |
Increasingly today, the company is forced to make difficult choices in order to satisfy its shareholder base while at the same time having to manage its operations. Dividend increases and tender offers are two important ways to increase investor confidence in your company and put excess cash into investors' hands.
What is a share repurchase?
It is a broad, (generic) term for a company repurchasing a portion of its outstanding shares.
It is a transaction, or a series of transactions, whereby a company goes into the marketplace and buys back shares in the open market or via a private transaction (where a company negotiates with a large stakeholder for a block of shares). Alternatively, a company can utilize a self- tender, either fixed-price or a Modified Dutch Auction. All of the above transactions have the same result: a reduction in the number of shares outstanding for a public company.
Why would companies want to repurchase their shares?
There could be several reasons, including:
| 1. |
They believe their stock is presently (historically) undervalued |
| 2. |
They have excess cash with no viable alternative investment ideas for growing their business, nor likely candidate/prospect for a merger or acquisition, |
| 3. |
To enhance financial leverage |
| 4. |
To return cash to shareholders |
What is an MDA? (Modified Dutch Auction)
This is a type of auction where a fixed supply of "something" is offered to the market. The bidding starts in reverse - i.e. at the highest point (not the lowest) and then goes down (not up) until the whole quantity is sold. The price point that allows the entire quantity to be sold becomes the clearing price and is given to everyone (even those who bid at a higher price).
In the case of a Modified Dutch Auction applied to a self-tender it is the company bidding for (not offering) a quantity of shares starting at the lowest price and then working up the price ladder to get to the clearing or equilibrium price. Once the desired quantity of shares is satisfied (this is made known in advance of the auction/tender), everyone who tendered at the determined clearing price (or lower) receives this price for the shares they tendered.
In a modified Dutch auction the company has a greater chance for success in buying its desired amount of shares, typically at lower cost. Fixed tenders generally are made at large premiums to prevailing market prices in order to attract shareholders to tender their shares.
How does an MDA transaction work?
The company, most commonly with the advice/guidance of a financial advisory firm, sets the terms of the deal. These terms include the amount of shares it wants to purchase, the price range that it wants to transact those purchases and the timing/expiration of the offer. A specific filing is done with the SEC, offering materials are sent to all eligible shareholders, and an advertisement (tombstone) is placed in a widely read publication and/or distributed through a news service.
Why would a company elect to use an MDA versus other approaches, e.g. fixed tender, share buyback, etc.?
In a modified Dutch auction the company has a greater chance for success in buying its desired amount of shares, typically at lower cost. Fixed tenders generally are made at large premiums to prevailing market prices in order to attract (entice) shareholders to tender their shares. With MDAs, shareholders have to choose at which price they want to tender their shares and if they offer too high a price they risk being priced out of the deal.
Straight Open Market Share Repurchases or "Buybacks" can be time consuming and may have little or no market impact and may result in weaker informational signals being sent to the market.
