Tender offers & buybacks | Trading | Common stock

Tender offers are utilized when an investor, group of investors, or an organization aims to obtain a significant portion of an issuer’s stock. Outside investors (those not connected to the issuer in any way) sometimes create tender offers to attempt a hostile takeover. As discussed earlier in this unit, common stock investors maintain voting rights. Investors with sizeable ownership levels can accumulate enough stock to “run the show” or force specific corporate actions.

Sidenote

Xerox's failed hostile takeover of HP

Let’s explore Xerox Holdings Corp’s (ticker: XRX) failed hostile takeover of HP Inc. (ticker: HPQ). Just before the attempt in late 2019, Xerox offered to purchase HP for roughly $33 billion. HP’s board of directors (BOD) swiftly rejected the offer and was quoted as saying:

“Xerox’s proposal significantly undervalues HP — and is not a basis for discussion.”

Although HP did not want part of this deal, Xerox kept moving forward with its intentions. With the help of billionaire investor Carl Icahn (who held large positions in both companies), Xerox obtained $24 billion in financing to obtain more shares (and more voting power) in HP in early 2020. Xerox then nominated 11 hand-picked individuals for BOD positions. With Xerox’s heightened voting power, most, if not all, could get voted in. From there, Xerox would make another offer to purchase and merge with HP. With their hand-picked BOD members in place, the deal could undoubtedly get done. This is a common way to perform a hostile takeover.

Unfortunately for Xerox, the COVID-19 crisis unfolded shortly after their takeover attempt in March 2020. Due to uncertainty caused by the pandemic, Xerox abandoned its takeover attempt. If the pandemic had never happened, it’s likely it would’ve worked.

For a hostile takeover to occur, more shares must be purchased by the “takeover” party. They could buy more shares from the market, which would flood the market with demand. The added demand would significantly drive up the stock price, making the acquisition more expensive. Most hostile takeovers utilize tender offers to avoid this problem.

Tender offers are direct proposals to purchase stock from current investors, typically at premium prices. To obtain more shares in HP in early 2020, Xerox offered HP investors $18.40 in cash and 0.149 shares of Xerox stock for every HP share tendered. At the time, this represented roughly $24 of value per HP share, while HP stock only traded around $17 per share. The $7 premium was Xerox tempting HP shareholders to sell their shares.

Current stockholders ultimately decide whether to tender their shares or reject the offer. To be eligible to tender, an investor must be long the stock. Investors with short positions cannot tender their stock. Also, investors with convertible securities can only tender once they’ve submitted irrevocable conversion instructions (e.g., HP convertible bondholder converts the security to HP common stock).

Definitions

Long: The purchase and subsequent ownership of a security
Short: The sale of borrowed securities
Convertible security: A security that is convertible into common stock of the same issuer

For example: an HP bond (a type of debt security) that is convertible into HP stock

There are a few regulations related to tender offers. Investors must be provided at least 20 business days to make their decision. If any aspects of the tender offer change (e.g., the tender price), the offer must be extended by another 10 business days.

While we’ve discussed tender offers for common stock, they can be extended for any security. Additionally, an issuer may perform tender offers for its own securities. For example, General Electric Company (ticker: GE) issued a tender offer for $5 billion of its outstanding debt in 2019.

Issuers may also purchase their securities from the open market. When this action occurs with stock, it’s referred to as a stock buyback. Issuers typically repurchase their shares to benefit their stockholders. With fewer outstanding shares, the issuer will report higher earnings per share (EPS) on their financial reports even if the company’s revenues stay flat. For example, let’s assume the following:

ABC Company

Outstanding shares: 1,000,000
2022 annual earnings: $5,000,000

Let’s establish the formula for earnings per share:

$EPS = \frac{Annual earnings}{Outstanding shares}$

$EPS = \frac{$5,000,000}{1,000,000}$

$EPS = $5.00$

Now, let’s assume ABC Company repurchases 200,000 shares in 2023, but reports the same annual earnings of $5 million. What’s the new EPS?

$EPS = \frac{$5,000,000}{800,000}$

$EPS = $6.25$

EPS is a figure many investors and analysts pay close attention to. Buybacks result in some EPS manipulation, but it costs money to perform stock buybacks. If the issuer can make up the money spent on the buybacks from their business revenue, their EPS will rise. Stock buybacks became a big focus on the political stage in 2020 because many issuers performing these buybacks needed financial support from the government during the COVID-19 crisis.

Key points

Hostile takeover

An unwanted attempt from one party to take over an issuer’s business
Typically involves the outsider:
- Purchasing significant stock positions
- Instilling hand-picked individuals into BOD positions
- New board structure bending to the will of the outsider

Tender offers

Proposal to purchase security from current investors
Offered at a premium to market price
Participants must be long the security
Must be available for at least 20 business days
Must be available for an additional 10 business days if offer changes

Stock buybacks

Issuer repurchases its shares from market
EPS increases with fewer shares outstanding

Earnings per share (EPS)

Earnings / outstanding shares
Measures profitability on a per share basis