How often these days does there come along a great trading opportunity for us small investors? We always tend to get the short end of the stick due to high fees, bad execution, and holding periods (for those of us who work in the industry), just to name a few.
Well, WebMD (WBMD) presented such an opportunity in the last month. On August 12th, the web health information company commenced a tender offer for up to five million shares of its common stock, and on September 16th, the final results were announced.
I made $272.21 (8.8% return) virtually risk-free in less than two weeks.
Details
For those of you who don't know how a tender offer works, don't worry, as an algo/derivatives trader, I also knew next to nothing about this before I did the trade (which is the main reason that I delayed posting this until I was sure it had worked).
WBMD offered to buy back up to 5 million out of approximately 50.4 million of its common stock at $34.00 per share. Shareholders can choose whether or not to participate in the offer. However, if more than 5 million shares are offered to be sold to WBMD (the tender offer is "oversubscribed"), then everyone involved gets their shares bought back on a pro rata basis. In other words, if 10 million shares are tendered, then shareholders would only get 50% of their total amount tendered at $34.00. However, some shareholders get priority: those who hold an odd lot (less than 100) number of shares.
On August 12th, the previous closing price of the stock was $33.40, so this is a profitable move if you buy at that time and get your shares tendered (excluding commissions and fees). And if you buy 99 shares like I did, you then maximize your profit without exposing yourself to the risk that your shares may not be tendered. I actually got in at $31.16, and after trading commissions (my broker did not charge for tendering, but some do), I made a nice $272.21.
Note: I entered my long position on August 27th, but my firm did not consider this a violation of the 30-day holding period (the dreaded rule many broker dealers have for their employees) since I did not sell my shares in the market. I imagine most firms will have the same policy.
I am sure some of you are now asking, "What's the catch?" and "Why does this work?"
Risks and Requirements
As for the first question, I did not really see a significant catch, but here are some (minimal) risks/requirements of the trade:
- You must have more than $3000 in capital.
- There are usually extreme circumstances that would cause the tender offer to be cancelled. Obviously, if the firm goes under during this period of time, it will be cancelled. I did not think this was an issue with a company like WebMD. Other tender offers will state that if the S&P 500 moves down X% during the period which the tender offer is open, then it will be cancelled. Both risks can be mostly mitigated by tendering your shares on the last day possible (in this case, six days before the results were announced) if it is still under the offer price (which it was).
- Over 50,505 people (assuming everyone does 99 shares, since 5,000,000 / 99 ~= 50,505) attempt this strategy (see below).
Reasoning and Analysis
Why does it work? First, let's answer the easy question: Why do most tender offers give odd lot shareholders priority? One of the reasons a company participates in a tender offer is to cut down on administrative fees that are not worth it to pay for smaller shareholders. Therefore, by giving priority to odd lot holders AND offering a premium to the market price, they give these people incentive to sell their shares to the company, which in turn lowers WebMD's fees, resulting in a win-win. There may be other reasons, so please elaborate in the comments below if you know of any.
Here's the harder question. Why did the stock price immediately jump to $34.00 after the announcement? My answer below is based on my own analysis/opinion and might not be correct, so please let me know in the comments what you think the reason is. I am very curious.
Note: In the following calculations, I am ignoring the odd lot shares, which I will analyze after the section.
I believe the reason the price stayed under $34.00 had everything to do with the fact that not everyone who wanted their shares tendered could guarantee that their shares would be purchased, and this indeed was the case: approximately 26.1 million shares were tendered excluding odd lots. This creates an expected value problem set up as such:
Market Price = (% of shares purchased) * ($34.00) + (1 - % of shares purchased) * (True Market Price disregarding tender offer)
"% of shares purchased" is the expected proportion of shares that a non-odd lot shareholder expects to be bought back in the tender offer (i.e. the pro rata proportion). What did the market think this number was during the offer period?
I believe that it was an unreasonably high percentage for most of the period that dropped to the real value when the results were released. This is because the stock price dropped nearly 5% on September 11th (from $33.46 to $31.85, even though SPY was up 0.3% that day), when the preliminary results of the tender offer were announced, stating that the pro rata rate would be around a low 18%. This implies that the shareholders had a much higher expectation of the "% of shares purchased" and were disappointed in this number.
Just because I was interested, I backed out what the market thought the "% of shares purchased" value was before the announcement using a modified form of the above formula assuming an unchanged SPY (but it looks terrible if I type it out so I didn't bother): 79%. This implies that the average shareholder who subscribed to the tender offer expected 79% of their shares to be purchased. In other words, the market believed that only a little over 6 million shares would be tendered; instead 26.1 million were. Whoops.
As for the odd lots, September 16th's final results stated that approximately 522,000 "odd lot" shares were part of the tender offer, so they were all purchased. That implies that a little over five thousand people used this strategy (more if you account for people with fewer than 99 shares). I also find this hard to believe; usually when there is free money to be made, everyone jumps on it. To be fair though, I looked up this strategy on Google during the offer period and couldn't find very much. Also, can someone tell me what happens if over 50,505 people employ this strategy? Does WBMD still guarantee that all odd lots get tendered, or will even they get their shares bought on a pro rata basis?
Conclusion
If you actually read all of that down to here, I applaud you and I hope you enjoyed this post. If you can help me answer some of my questions, I'd really appreciate it. And since it worked this time, I will share future similar strategies with you guys before the deadline so we can all share the free money!
This is an awesome post - thanks so much for the info.
I don't have any answers to your questions but I'd love to hear what people have to say.
Also, how did you hear about this tender offer? I realize that the company must publicly announce it, but is there a way to filter some sort of news-feed of all public companies making tender offer announcements? And further, do all companies make these "odd-lot" offers? I see the benefits to them, but I still could see some companies not making that provision.
Thanks!
I have been doing this strategy for about 2 years now. Word of advice: DO NOT ANNOUNCE THESE DEALS ON A PUBLIC FORUM. Do it through PM or a chat room. Around 2011 there was a russian ADR which gave $7K on a deal like this.
Anyway, the reason I say keep it private is because *****If too many people get a hold of this strategy, companies will stop offering it.******
Some idiot wrote a SeekingAlpha article about the odd lot tender with The India Fund, and they immediately discontinued it.
http://online.wsj.com/article/PR-CO-20130513-906828.html
Please do not announce deals on public forums like WSO or even facebook/twitter/blogs. You'll ruin it for everyone :(
Should the mod delete this thread?
Fine I won't "announce" future ones on WSO. But this has already happened so no harm done. I just want to know what you guys think.
I'm not sure exactly how you arrived at the 79% but using the R/C in the options market the implied pro-ration was rough 20%, which seems pretty standard for these kind of events.
Before that pro-ration rate of 18% was announced, I think the market expected something higher, as evidenced by the large drop in stock price upon the announcement.
peyo,
I'm trying to point out, in a graph of price vs time of WBMD, when this event happened. I can't see a time, in this past year, where the stock went to $34 fast, and dropped to $31 after the announcement. But can you put some dates to the events of this trade? Maybe this is asking for too much, particularly after how an*al the response from other traders in the forum has been (which I def. understand). It would help me better understand this trade. Thanks.
EDIT: Upon further "research", it seems that WebMD announced the tender offer on August 12, 2013. The stock seems to have close at around $33.70 (per Google Finance graph). So the premium WebMD was paying with their tender offer was about 1% (which does not seems like much to me). I could not find out if the tender offer announcement came before or after the market was closed. My guess is that it came after the market close. The next day, the stock opened slightly higher, but lower than $34. That means that if you got in there, your gains where going to be way lower (about 0.5%), and without assurance of making that return in two weeks, since there was no guarantee of your whole 99 shares being bought.
What I don't understand is why the stock then started going down in price the next 11 sessions, all the way down to ~$30.85. If you (peyo) got in at $31.16, you basically got it on August 27 or August 28, and pretty much at the bottom of the trend. That is why you made some good money for your 99 shares bet. But had you got in at the time of the announcement, then you would have made about 30 cents per share ($0.30*99 = $29.70 - commissions). Peyo, did you wait until you saw that your entry price ($31.16) was good enough to make a good enough profit (worth your time and risk)?
Another question I have is why did the stock started going down in price, when WebMD had made the decision to buy about 10% of the shares outstanding at $34. Shouldn't the price of WBMD be pulled by "gravity of the tender offer" at slightly less than $34? My intuition tells me this should be the case, but clearly I'm wrong since that is not what happened.
Whoops typo. I meant: "Why didn't the stock price immediately jump to $34.00 after the announcement?"
I would have done it for $30. Free money is free money.
My questions are the same as yours haha.
Wow, lots of misinformation in the comments. OP, it was kind of you to share.
Odd lot arbitrage is a great boon to the small investor, and there are typically a few of them every year. It's going to go away eventually, but not because of interest from a handful of retail investors. (The India Fund may have recognized that people were abusing the process since they did a regular tender semi-annually.)
The practice originates from higher commissions that were historically charged by brokers for handling orders not in standard lot sizes. Also, it's a convenience for retail investors not to have their piddling HFT) between odd lots and whole lots, and why should they on an all electronic platform? As brokerage commissions continue to decline, the practice is becoming rarer, but it's nice while it still exists.
That said, it's not that often a tender, prorated or not, occurs at a huge premium to the share price. For all the folks speculating about why the price moved as it did - buying back 10% of the shares is generally a positive thing (in WBMD's case, I would argue it's destroying value in the long run because their shares are overpriced, but no one asked me), but it's not going to put a floor on the share price for the exact reason we've been discussing. Any institutional investor who tenders is going to get prorated and still own 90% of their shares. (If the price is below the tender price, pretty much everyone except restricted, lazy, or certain taxable investors wanting to avoid a short-term gain will tender all their shares and then buy back whatever was purchased at the lower market price). So just because the company decides to overpay for some shares doesn't mean the shares are worth the price they're paying.
As a result, I very much doubt the price movement over the last month or so had much to do with the tender at all - think of it just like an announced share buyback program, only it's happening all at once. The market wasn't expecting a particular proration percentage, it was just valuing WBMD like normal, which included a sell-off in late August along with the broader market.
If you want to play these in the future, note they are not risk free. Read the SC-13TO filings carefully; WBMD had the right to cancel or modify the tender price if its stock declined by 20% from the offer date (10% is a more common threshold). I bought some around $31 too and tendered, but had the price dropped to $28, we could have been left holding the bag.
Really appreciate the response/explanation. Most of it was in line with what I believed, so I'm glad I wasn't completely wrong about what I was saying.
If there is a range, say a company agrees to a offer range that is less than $21.50 but greather than $20.00 per share, does the company ever pay above the minium offer price?
I haven't seen that before, so I don't know.
Aut quia dignissimos sit numquam et harum est excepturi. Eum incidunt mollitia facilis porro sint deleniti quia aut. Aut cupiditate facilis cupiditate sed. Eius eligendi recusandae quos officia nesciunt voluptate.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...