Pity the poor Dutch

Peter Hodson

Pity the poor Dutch. In financial history, nearly every text or historian refers to the Great Tulip Bubble, as a key example of financial markets gone mad. In the ensuing Tulip Crash of 1637 thousands lost, well, thousands (back then a thousand was actually worth something, before centuries of inflation kicked in).

So the Dutch now have to deal with being a shining symbol of extreme market mania for perhaps all eternity. However, maybe they can console themselves with the positive benefits of a Dutch auction, a much better financial market invention.

In security markets, a Dutch auction, or Modified Dutch Auction, is when a company decides to buy back shares, and lets investors partially determine the clearing price of the buyback. Unlike under a Normal Course Issuer Bid (NCIB), a company in a Dutch auction can buy back a lot of shares in one fell swoop, rather than over a one-year period.

Here is an abbreviated Wikipedia definition: A Dutch auction offer specifies a price range within which the shares will be purchased. Shareholders are invited to tender their stock, if they desire, at any price within the stated range. The purchase price is the lowest price that allows a company to buy the number of shares sought in the offer, and the firm pays that price to all investors who tendered at or below that price. If the number of shares tendered exceeds the number sought, then the company purchases less than all shares tendered at or below the purchase price on a pro rata basis to all who tendered at or below the purchase price. If too few shares are tendered, then the firm either cancels the offer (provided it had been made conditional on a minimum acceptance), or it buys back all tendered shares at the maximum price.

In simple terms, a Dutch auction gives investors a chance to sell some of their shares back to a company for cancellation, often at a small premium. Plus, there are no brokerage costs. The company gets to buy and cancel a set number of shares, hoping to improve its earnings overall.

Why would a company execute a Dutch auction? Well, like under a NCIB, it would do an auction if it believed its shares were undervalued, and it had the cash or debt capacity to buy back a lot of shares. In theory, this will eventually improve per-share earnings and the company’s valuation, if earnings growth exceeds interest earned on otherwise idle cash or interest paid on borrowed money used in the buyback.

Let’s quickly look a four recent Canadian companies that announced or completed Dutch auctions and large substantial issuer bids.

Agrium: Agrium recently completed a $956 million buyback of shares at $105.82. Shares hit a new high just after the deal, but are more or less the same price now. In what some term a ‘sneaky’ move, Agrium doubled its dividend immediately after its buyback was complete. Shares are up 55% this year.

Great Canadian Gaming: This gaming company bought back $100 million in shares at $10 each this summer. Shares are below the auction price now, but still up 14% on the year.

Danier Leather: Danier last week announced a $10 million substantial issuer bid. Shares popped 10%, and are up 15% this year. Interestingly, investors always complain that Danier’s shares are not liquid enough. Taking out more shares in a buyback is not going to help this any. More likely, the buyback looks like another step in a long, slow process to eventually privatize the company.

Celestica: Celestica recently announced the terms of a $175 million Dutch auction. It plans to pay between $7 and $8 per share in the buyback. Shares didn’t move much on the news, and are still down 4% for the year.

Do these auctions work? Well, unlike a NCIB, investors at least can see some fairly fast results and shares are actually bought. Many companies put an NCIB in place and then never actually buyback any shares. Reducing the number of shares outstanding, in our view, is typically a good thing. However, in current market conditions, it looks like investors far prefer regular dividends to any stock buybacks.

by Peter Hodson, editor

Canadian MoneySaver