I've had so much fun talking about convertible-financed share repurchases the last few days that I'm going to move on to talk about share-financed share repurchases, which are my even more favorite trades. The nice thing about a convertible-financed share repurchase is the efficient linkage of the convertible and the share repurchase (which you buy instantly and efficiently from the hedge funds who buy the convertible). It's all snaps together perfectly, with no slippage, though sometimes weird stuff happens.
The nice thing about a share-financed share repurchase is that it makes no sense at all. It's just a terrible capital markets joke.1 Why would you sell stock to buy back stock? One, it's pointless -- you end up where you began. And two, there will be slippage: You'll sell stock at a discount, and then buy it back at a premium.
Coca-Cola Co. (KO) agreed to buy a 10 percent stake in Green Mountain Coffee Roasters Inc. (GMCR) for about $1.25 billion and work with the maker of Keurig coffee brewers to introduce a system for producing single-serve cold drinks.
Coca-Cola is buying the 16.7 million newly issued shares for about $74.98 apiece, the companies said yesterday in a statement.
That's the share financing. Here's the share repurchase:
GMCR intends to execute a meaningful share repurchase program to reduce dilution from the transaction. This will be executed under the Company’s existing $1.1 billion share repurchase authorization.
Of course this is much more of a business transaction than a corporate finance one. That announcement goes on to say that "GMCR intends to use a portion of the proceeds from the new equity issuance to fund anticipated capital expenditures for its Keurig Cold™ beverage system over the next several years," though it doesn't give a breakdown of capex versus share repurchase. And analysts, and the market, seem to be pretty ecstatic about Green Mountain's bright future as a maker of Coke-branded pod-based drink things. Also who can argue with this:
“This is what consumers told us they wanted,” Green Mountain CEO Brian Kelley said on the call. Coca-Cola cold-drink brands are “popular,” he said.
But as a corporate finance transaction it's sort of neat. In effect, Coke is buying shares from Green Mountain shareholders, with Green Mountain standing between them and collecting an enormously negative spread. Coke bought Green Mountain shares at $74.98, a discount to yesterday's price,2 and Green Mountain will use the proceeds to buy shares from the public at, I think it's safe to say, a huge premium to yesterday's price. Green Mountain opened at $110 today, up 36 percent from yesterday's close. So Green Mountain is selling at $75 to finance buying at $110.
Still, it's easy to like the trade. It makes sense for Coke to buy a stake in Green Mountain: it "fits into Coca-Cola’s preferred strategy of taking equity stakes in promising new brands and technologies, such as Zico coconut water and Honest Tea, and helping incubate them." And it makes sense for Coke to pay more or less yesterday's price: Today's run-up is due mostly to the fact that Coke is giving Green Mountain its seal of approval. (And also somewhat to the fact that there are big noisy Green Mountain shorts, and this announcement is giving them the ol' squeeze.) That's value Coke is adding, so Coke really shouldn't be paying for it.3
Green Mountain, on the other hand, is happy to get the seal of approval, and it is thrilled to squeeze the shorts, that is just free entertainment for Green Mountain. But it is also apparently not in need of Coke's $1.25 billion. And it's in buyback mode anyway, making a big new equity issuance for more money than is really required is sort of awkward to explain to (otherwise ecstatic) shareholders. Since it's benefiting from the broader transaction, it makes sense for it to take a big loss on buying Coke's shares for it.4 Every so often, the share-financed share repurchase can make sense.
Banking: Hey can we think of a really creative trade for XYZ Co. to do to improve its EPS?
Capital Markets: What about increasing revenues or cutting costs?
Banking: *puzzled silence*
Capital Markets: What about a stock buyback?
Banking: They don't have any money.
Capital Markets: What about a convertible financed stock buyback?
Banking: Their covenants won't let them do any debt.
Capital Markets: What about a stock-financed stock buyback?
Banking: Sounds great, let's fly out there tomorrow and pitch it to them. Really creatively!
Capital Markets: Uggghhhhhhhhhhh.
Turns out this is no funnier in person.
2 Oh no sorry it bought at "$74.98, which represents the trailing 50-trading-day volume weighted average price ('VWAP') as of market close" yesterday. And which also represents a 7 percent discount to yesterday's close. Also they bought after the close yesterday, not over the last 50 trading days. Just saying.
3 Why Coke should be getting a discount to the last pre-announcement price is less clear. Sometimes people use long-term average prices because they think the deal may have leaked and they want an approximation of the unaffected price. Sometimes it's just, like, a price, man: Coke is transferring some value (money, brand partnership), and Green Mountain is transferring some value (shares, brand partnership), and you negotiate how much value each side gets and do your residual tweaking in the price of the shares.
4 It helps that the "loss" from selling shares at $75 and buying them at $100+ is an economic loss but not an accounting one. Buying and selling your own shares doesn't generate accounting income.
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