Corporate stock buybacks are common these days, but the TRW Inc. buyback that began yesterday is unusual in that it allows shareholders to participate in determining the price.
Most corporate stock buybacks are accomplished through open market purchases or through an offer to purchase shares for a specific price. The buyback price typically is set by the corporate board of directors.
Instead of these traditional approaches, TRW, relying on the advice of Morgan Stanley and Salomon Brothers, is using the "dutch auction" technique. Under this method, shareholders of the Cleveland company are invited to offer to sell their stock at whatever prices they choose between $80 and $88 a share.
TRW guarantees it will buy at least 5 million and up to 8 million shares. TRW stockholders have until Oct. 15 to offer to sell any or all of their shares in that price range. A stockholder can even divide up his shares, offering some at one price and the rest at another.
Once the stockholder bids are in, TRW will select a purchase price high enough to enable the company to buy at least 5 million shares. TRW will buy all the shares it purchases at the same price. For example, if TRW selects a price of $84 a share, all shares offered for sale by stockholders between $80 and $84 a share would be purchased for $84 a share. Those who offered to sell shares for more than $84 a share would be out of luck.
Its complexity may be one reason why TRW is one of only a few companies, including Holiday Corp. and FMC Corp., that have used the dutch auction technique to repurchase shares recently.
Why is TRW using the technique?
"We are trying to bring the market forces into play in setting the price of the tender offer," a TRW source said. "This dutch auction technique is used quite commonly in the government securities market, and we decided it would be a worthwhile technique to employ here. It puts the market to work in helping the company fix a fair price in the tender offer."
There are other reasons why TRW chose the dutch auction. At the same time that TRW announced the stock buyback last Friday, the company announced a major corporate restructuring that includes the sale of its industrial products and aircraft components groups. Divesting these businesses, which had combined sales of about $700 million last year, would leave TRW with operations focused on automotive products and electronic systems for defense and space.
Because the future stock market valuation of TRW could be influenced significantly by these divestitures, the company decided to use the dutch auction to let the market, rather than the company's directors, determine the tender offer price.
"Since TRW will be a new company after the restructuring, the dutch auction gives investors the chance to evaluate the new company and tender their shares at prices they think are appropriate," one Wall Street source said. "Also, it gives TRW more flexibility. They will be able to see where the market puts a high value on their shares, and this may allow them to repurchase shares at a lower price" than if they used a traditional buyback offer at a specified price.
FMC Corp.'s Cheryl Francis, who was director of investor relations when that company conducted a dutch auction buyback last year, said the FMC program did not end up saving the company any money. FMC had asked shareholders to tender their shares at prices between $51 and $54 a share.
"We thought we could get a more competitive price using the dutch auction method since people would tender their shares for the minimum price" they thought would be the cutoff, Francis said. "We ended up buying back all the shares that were tendered at our top price" of $54.
Holiday Corp. chief financial officer Charles Solomonson said the Memphis-based parent of Holiday Inn used a dutch auction to repurchase shares earlier this year because "we thought it was an innovative technique that would be cost-effective." But the company ended up buying back more than 6 million shares at $49 a share, the top of its $46 to $49 range.
"We got no negative reaction from shareholders," Solomonson said, when asked if the program was too complex. "The most humorous thing was when a shareholder in Holland called me and asked what a dutch auction was."