Reading: Payout Basics

There are numerous ways for firms to repurchase their shares, in particular:

• Open market buyback programs 
• Fixed-price tender offers
• Dutch auctions
• Privately negotiated deals
• Transferable put rights (TPRs)

 

In what follows, we briefly discuss the highlights of these alternative buyback methods. For a more detailed discussion of the regulatory requirements surrounding share repurchases, see the Harvard Law School Forum on Corporate Governance and Financial Regulation and the literature cited therein.

  

Open market share repurchase 

Just as any other stock market participant, firms can buy shares in the open market at the prevailing stock price. With approximately 90% of the announced repurchase volume, this is the predominant buyback form in the U.S. An open market program gives firms maximum flexibility with respect to the amount and timing of the buyback activities. However, to protect against allegations of market manipulation, firms have to respect certain volume and price restrictions when buying back shares. Most notably, Rule 10b-8 of the Securities Exchange Act of 1934 dictates:

• Repurchase volume: On any given day, the aggregate purchases must not exceed 25% of the securities average daily trading volume.
• Repurchase price: Moreover, the repurchase price cannot exceed the highest independent bid price or the last independent transaction price at the time of the purchase. 

Therefore, while open market programs are generally the cheapest way to repurchase shares, it can take a significant amount of time and trading activities to complete a program.

 

Fixed-price tender offer

In a fixed-price tender offer, a company offers to repurchase a given number of shares at a given price (the so-called tender price) over a given period of time. For example, the Swiss elevator manufacturer Schindler Holding Ltd. announced on October 18, 2013 the following fixed-price buyback program (see here for the full announcement):

• Number of shares to be repurchased: Up to 4.1 million registered shares and up to 4.1 million of participation certificates.
• Repurchase (tender) price: CHF 129.00 per registered share and CHF 129.80 per participation certificate.
• Duration of the program: November 1 2013 to November 14 2013.

Because the program did not offer a significant premium to the tendering shareholders, Schindler's buyback was only partially successful. Upon closure of the program, shareholders have only tendered 2.4 million registered shares and 0.6 million participation certificates.

 

This case also highlights one of the key challenges surrounding fixed-price tender offers: On the one hand, shareholders will be reluctant to tender their shares as long as the tender price is at or below the market price. On the other hand, if the tender price significantly exceeds the market price, the offer will be oversubscribed and the company will have to make a pro-rata allocation of the repurchased shares. That might also leave the taste that the company has paid too high a price to repurchase shares, which results in a distribution of value from the remaining shareholders to the selling shareholders.

 

Dutch auction tender offer

This challenge could be addressed with a Dutch auction tender offer. Instead of specifying a fixed repurchase price, the firm indicates a price range within which the tendering shareholders indicate their minimum acceptable selling price. Upon expiration of the tender offer, the firm then establishes the supply curve for its shares based on the submitted bids and sets the repurchase price as the lowest price that allows the firm to buyback the desired number of shares. This price is then paid to all investors who offered to sell their shares at or below that value (possibly on a prorated basis in the case of oversubscription).

A case in point is Expedia's repurchase program in 2007:

• Back then, the firm has thought to repurchase up to 25 million shares of its common stock at a price no lower than $27.50 and no higher than $30.00.
• When the offer expired at 5pm on August 8, 2007, a total of 62.2 million shares of common stock were properly tendered at prices within the stated range. Of these shares, approximately 30.1 million were tendered at prices at or below $29.00.
• Subsequently, the firm decided to set the repurchase price at $29.00 per share. 
• Since more than 25 million shares were tendered at or below that price, Expedia only purchased a prorated portion (namely approximately 80%) of the tendered shares by each tendering shareholder.

  

If the firm sets the repurchase price range too low, it risks that the program fails. This happened to Microsoft back in 2006, when the company thought to repurchase more than 800 million shares at a price of up to $24.75. However, only 155 million shares were actually tendered at or below that price. In such a case, unless the program has been made conditional on a minimum acceptance, the firm then has to pay the maximum price to repurchase the tendered shares.

 

If successful, the Dutch auction is generally the cheapest way to repurchase a specific number of shares within a short period of time. A nice side effect of the structure is that it repurchases the shares from the most pessimistic investors (i.e., those with the lowest valuations). This can add stability to the (remaining) shareholder base.

 

Privately negotiated repurchases

Finally, firms, in principle, could also repurchase shares from large shareholders in privately negotiated transactions. This could be an attractive option for firms with thinly traded shares or with private equity investors who want to exit. A case in point is Sonus Networks, who announced in August 2013 that it would repurchase approximately 3.1 million shares of common stock in a privately negotiated transaction from a private equity investor. The repurchase price corresponded to the stock's market closing price.

Privately negotiated repurchases are often made in combination with open market repurchase programs. That was also the case for Sonus Networks.

In a tactic called "Greenmailing" that was popular in the 1980ies and 1990ies, aggressive investors purchased a sufficient number of shares to challenge the incumbent management with a (hostile) takeover threat. In order to prevent potential takeover, the attacked firms then often engaged in privately negotiated buybacks to repurchase the shares from the hostile shareholders at a premium.

However, since privately negotiated buybacks do not fall under the Rule 10b-18 safe harbor discussed above, such buybacks raise concerns about the equal treatment of shareholders and they could also be in violation of the SEC's anti-fraud and anti-manipulation provisions. Therefore, firms nowadays exert great caution when negotiating private deals.

Please refer to the research paper by Peyer and Vermaelen for a comprehensive discussion of the many facets of privately negotiated buybacks.

 

Transferable Put Rights (TPRs)

Finally, a firm could also issue put options to its shareholders. With these options, shareholders receive the right to sell the firm a share of common stock at a given price (the option's "strike" price) within a given period of time (time to maturity). These put rights are usually transferable, in the sense that shareholders who do not exercise them can trade them in the capital market. Hence the name "Transferable Put Rights," or TPRs.