Yesterday afternoon, Thomson Reuters announced that it was repurchasing 6.5 million shares of stock in privately arranged transactions as part of its efforts to repurchase approximately 37 million shares through May 2017. As part of the disclosure, Thomson Reuters noted that the privately arranged transactions will occur at prices that are discounted from the quoted market value. You might wonder: Why would these transactions occur below market value rather at market value?
The short answer: It is all about liquidity.
If someone wants to sell 6 million shares of Thomson Reuters on September 26th, the creation of a single sell order would flood the market and drag down the price of the stock immediately. Any sale would have to be spaced out over months (sometimes even years) so that you don’t compete against yourself in the marketplace.
What Thomas Reuters the corporation is doing here is providing large investors the opportunity to unload their shares without affecting the equilibrium of the market. You can unload 6 million shares on Thomson Reuters, and they will in fact make each share more valuable because they will destroy the stock and increase the intrinsic value of the remaining shares.
This liquidity advantage is especially true if someone is sitting on a large block of TRI.TO stock and fears that the price will fall during the month-long period that it will take to sell off the stock. At a price of $54 per share, this is not an irrational concern. Just three years ago, you could’ve bought the stock at 13x earnings. Now it trades at 25x earnings. Because of the scalability of intellectual property, Thomson Reuters boasts a solid 13% profit margin. But it also doesn’t have a lot of room to grow, and so the stock usually relies on core earnings per share growth of three percentage points and an additional four percentage points created through dividend payments and share repurchases. It’s easy to understand why an investor would appreciate a liquidity advantage that provides an opportunity to get rid of a stock trading at 25x earnings and only growing in the mid single digits.
The rationale for why an investor sitting on millions of shares would be willing to sell directly to Thomson Reuters at, say, 0.9x rather than going directly to the market at x is that they either need the money now or believe that the price of the stock will fall by 0.1x or greater during the prolonged period that it would take to dispose of the stock. The below-market price acts as a transaction cost in which Thomson Reuters the corporation is providing value through its willingness to absorb hundreds or millions of shares of TRI.TO stock in a single transaction.
The rationale for why Thomson Reuters would be doing this is also pretty clear. It is committed to buying 37 million shares in the next year, and it benefits by purchasing them in privately arranged blocks because it can destroy shares and boost earnings per share at a lower price than would be the case if the corporation relied exclusively on the marketplace for its stock.
I should mention that it is not always the case that privately arranged transactions occur at a discount to the prevailing market value. Sometimes, giant blocks of stock are more valuable even though they can’t be sold all at once. For instance, the Articles of Incorporation may provide for board seat representation once you own a certain percentage of stock, and the privately arranged block might impliedly carry the right to name some board members in the transaction as well.
Also, if you are planning a corporate takeover, and want to sidestep management and the sitting board, a privately arranged transaction may permit you to sidestep the onus of the Williams Act a little bit. The Williams Act requires investors to publicly disclose stock ownership positions of at least 5% in any publicly traded companies. This is meant to discourage sneak attacks and provide a warning bell to incumbent management that a takeover of the firm may be in the offing.
Another reason why there may be a premium attached to the stock is because the investor community believes that the stock will rise in the interim. It has taken Warren Buffett over two decades to build up his position in Wells Fargo. Without bidding the price up, it would take at least 3 years to build up a similarly sized position. It’s the reverse of our analysis above. Here, if you believe that the price of the stock over the months or years it would take you to assemble your position would be higher than the premium you would be required to pay all at once initially, paying a premium for a privately arranged block of stock would make sense.
Usually, companies with stable cash flows also come attached with their own premium with privately negotiated transactions. If you had to take on debt to purchase 6 million shares of Thomson Reuters, it might make sense to pay a premium since you would be receiving an immediate dividend cash flow of $8 million that could be used to pay the borrowing costs so the position could effectively fund itself.
That rationale is partially why the MLP energy market crashed so hard in 2014 and 2015. Many well-heeled investors were borrowing at 2-5% and buying MLPs yielding 8-12% annually. The distributions were paying off the interest and even providing a gap so that the distributions could help pay down the principal on the debt, too. When the distributions got cut amidst falling prices, this strategy broke down and triggered margin calls—hence the rapid spiral downward in the stock price.
Just because Thomson Reuters announces an intention to purchase its own stock below market price does not mean that investors in fact will come calling. It would not surprise me if this arrangement went partially filled. If you plan to sell Thomson Reuters stock, and aren’t concerned about an impending price drop and don’t have a higher opportunity cost investment on the horizon, you’ll just go through the market rather than sell all at once at a discount.
A privately arranged deal confers no special significance. It just usually means a larger amount of stock is involved than the typical trade, and the typical forces that affect stock prices are amplified by the larger sizes of the trade. If I had to guess, the incentive for investors to pursue this deal with Thomson Reuters involves institutions concerned that the price will fall in the short term as a consequence of its 25x earnings valuation.