Question

Briefly discuss the methods available for a company to buy back its shares and explain why you might expect the share price reaction to the announcement of each of these methods to differ.

Answer 1

Methods of buyback

Buying From Open Market

In this method of share buyback, the company buys its own stocks from the market. This transaction happens through company’s brokers. This repurchase program happens for an extended period of time as a large block of shares needs to be bought. The company is under no obligation to conduct the repurchase program after the announcement. The company has the option to cancel it. Also, it can make changes in the repurchase program according to company’s situations and needs. If this method is effectively implemented, it can prove to be very cost effective.

Fixed Price Tender Offer

In this method, the company makes an offer to buy a fixed no. of share at a fixed price to its shareholders. The price offered by the company is above the current market price. The shareholders have the option to sell back the share or hold the shares. Interested shareholders submit the no. of shares they are willing to sell back to the company. If total no. of shares exceeds the shares required by the company, shares are bought back on a pro-rata basis. This method can be conducted quickly but it can be costlier than buying shares back from the open market.

Dutch Auction Tender Offer

This is very similar to fixed price tender offer. Instead of specifying a fixed price, the company offers a range of prices to the shareholders. The minimum price is above the current market price. For example, a stock is currently trading at $100. The company offers to buy back 2 million shares within the range of $101 to $103. Investors will bid the no. of shares and the minimum price at which he/she wants to sell the shares. The company will start qualifying bids from $101 and move to higher prices until requirement of fixed no. of shares is fulfilled. If at $102 the requirement of 2 million shares is fulfilled, every qualified bidder is paid $102. Bids above $102 will be rejected. If total bidding at $101 and $102 exceeds the requirement of shares then shares are allotted on a pro-rata basis.

Repurchase by Direct Negotiation

In this method, the company approaches only those shareholders who have a large block of shares. They are paid a premium above the current market price. This is more logical approach as the company can directly negotiate with large shareholders.