In a cash tender offer, cash is offered to company stockholders in exchange for their shares. These deals can offer investors attractive returns.
Investing in cash tender offers can be rewarding indeed. According to a published article, investors would have turned $10,000 into $70,600 from 1981 to 1995 by buying the target company’s shares a day after the announcement and holding until the deal closed. The same amount invested in the stock market would have grown to $31,400. While these results are impressive, there could be periods when you’d lose money. And, there’s no guarantee this strategy will work in the future.
Acquirers include hedge funds, private equity, management led investor groups, and other corporations. The day after the announcement, the target company’s shares often trade below or at a “discount” to the offer price. The size of the discount reflects the uncertainty and time to completion of the deal. As the closing date nears and concerns about the deal are resolved, this spread usually narrows. In part, it’s the increase in share price between the day after the announcement until the closing date that offers the potential for gains. If the discount widens, then perhaps there’s trouble afoot. The deal price could be lowered or worse, the deal could fall apart altogether.
Occasionally, the target company’s shares will trade above or at a “premium” to the offer price. This is generally an indication that arbitrageurs expect the offer to be increased. Perhaps shareholders intend to resist the bid because the price is too low. The acquirer may have to offer a higher price to get their approval. Or a competing offer is anticipated by the market. The emergence of another suitor could result in a bidding contest, pushing the stock higher and higher.
Midwest Air Group was the subject of a protracted bidding war. Air Tran first bid $4.50 a share for Midwest in late-2006 but met resistance from Midwest’s board. In an effort to consummate the deal, Air Tran upped its bid several times. Then, in a surprise development, private equity firm TPG Capital made a $16.00 cash bid in August 2007. Air Tran responded with a $16.25 cash and stock offer. Just days later, Midwest’s board announced that it had unanimously approved a sweetened TPG’s all cash offer of $17.00 a share. News of Northwest’s proposed sale to Delta Airlines clouded expectations for a timely close but TPG completed the transaction in late January 2008, ending a nearly two year bidding war.
There have been losses. The leveraged buyout of SLM Corporation (SLM) by JC Flowers, a private equity fund, fell apart soon after Congress passed legislation in late 2007 lowering the rates lenders could charge on student loans. JC cited the legislation as constituting a material adverse event or “MAE” and withdrew its $60 offer. The stock price unraveled along with the deal and recently traded near $10 a share.
With many deals wrapping up in less than a year, most gains or losses will be short-term. This makes tax-deferred retirement accounts, like IRAs, better suited for participating in cash tender offers than taxable accounts.
In spite of some spectacular failures, most tender offers have been successful. Intrepid investors may want to consider participating in a handful of cash tender offer situations. After a promising start, we unwound our positions in late 2008 after realizing substantial losses during the market crisis.