Treasury Stock Method and its Importance

In simple terms when a company repurchases shares, they may either be canceled or held for reissue. If not canceled, such shares are referred to as treasury shares. Technically, a repurchased share is a company's own share that has been bought back after having been issued and fully paid OR in another context it can also be said that a treasury stock or reacquired stock is stock which is bought back by the issuing company, reducing the amount of outstanding stock on the open market (common shares).

Stock repurchases are often used as a tax-efficient method to put cash into shareholders' hands, rather than paying dividends. Sometimes, companies do this when they feel that their stock is undervalued on the open market. Other times, companies do this to provide a "bonus" to incentive compensation plans for employees. Rather than receive cash, recipients receive an asset that might appreciate in value faster than cash saved in a bank account. Another motive for stock repurchase is to protect the company against a takeover threat.

Limitations of Treasury Stock:

·         Treasury stock does not pay a dividend

·         Treasury stock has no voting rights

·         Total treasury stock cannot exceed the maximum proportion of total capitalization specified by law in the relevant country

The possession of treasury shares does not give the company the right to vote, to exercise pre-emptive rights as a shareholder, to receive cash dividends, or to receive assets on company liquidation. Treasury shares are essentially the same as unissued capital and no one advocates classifying unissued share capital as an asset on the balance sheet, as an asset should have probable future economic benefits. Treasury shares simply reduce ordinary share capital.

Importance of the Treasury Method:

This method comes into picture when we need to deal with the reduction in earnings (EPS) of common stock that occurs through the issuance of additional shares at the exercise of stock options or warrants or the conversion of convertible securities. An investor should carefully consider the fully diluted share amount because it can cause a company’s share price to plummet significantly if a large number of option holders or convertible bond holders decide to claim their stock.

Thus method is one of the most commonly used methods to value the options/warrants for the calculation of enterprise value. The purpose of this method is to account for the cash generated by the exercise of options/ or warrants. It assumes that the proceeds that a company receives from an in-the-money (options are in the money if its exercise price is less than the share prices) option exercises are used to repurchase common shares in the market. The net new shares that are potentially created is calculated by taking the number of shares that are in-the-money options purchase, then subtracting the number of common shares that the company can purchase from the market with the option proceeds. The net new shares are added to the basic shares outstanding to get the fully diluted shares outstanding which are used to calculate the diluted equity value. An example has been illustrated for better understanding the Treasury Method concept.

Example:

Current share price:                            $50

Share outstanding:                             400mm

Options/warrants outstanding:             10mm

Exercise price:                                   $25

Proceeds from conversion:                  10*$25 = $250mm

Stock buyback (at premium):               $250/$50 = 5mm

Diluted shares:                                   400 + 10 – 5 = 405mm

Check out space for effects of convertibles on EPS……..

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Bulge Bracket Vs Boutiques

The term “Bulge Bracket” generally refers to the large investment banks that cover most or all industries and offer most or all of the various types of investment banking services.   While there is no official list of bulge bracket banks, most people would consider the following banks to be bulge bracket: Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Morgan Stanley and UBS.

Pretty much all banks that are not considered “Bulge Bracket” are referred to as being “Boutiques”.  Boutiques, while ranging in size from a few professionals to hundreds or even thousands of professionals, can generally be categorized into three types:  (1) those that specialize in one or more products, (2) those that specialize in one or more industries and (3) those that specialize in small or mid-sized deals and small or mid-sized clients (generally less than $500 million).

There are boutiques that specialize in any number of the products that bulge bracket banks offer.  Boutiques known for M&A, for example, often compete with the bulge bracket banks for M&A transactions.  A few examples include Lazard, Greenhill, Evercore and Gleacher.  Other boutiques offer many different products but specialize in one or more industries.  Such boutiques often compete with the bulge bracket banks on the basis of their industry knowledge and expertise.  A few examples include Cowen & Co. (healthcare), Allen & Co. (media) and Thomas Weisel Partners (technology).  The third type of boutique, those that offer many products and cover many industries but compete only for “middle market” or smaller deals include Jefferies & Co., Piper Jaffray, Raymond James and Robert W. Baird.  Many of these middle market boutiques are regionally focused. Some boutiques, including several of the M&A focused banks, are considered to be as (or even more) prestigious as the bulge bracket banks.

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Bonds??

Bonds are debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities and states to finance a variety of projects and activities. Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents.

The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will be paid when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds is usually paid every six months (semi-annually). One of the common bonds we come across is convertible bond. It’s a bond that can be converted into a predetermined amount of the company's equity at certain times during its life, usually at the discretion of the bondholder. 

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Treasury Shares

Treasury shares are the portion of shares that a company keeps in their own treasury. Treasury stock may have come from a repurchase or buyback from shareholders; or it may have never been issued to the public in the first place. These shares don't pay dividends, have no voting rights, and should not be included in shares outstanding calculations.

Treasury stock is often created when shares of a company are initially issued. In this case, not all shares are issued to the public, as some are kept in the company’s treasury to be used to create extra cash should it be needed. Another reason may be to keep a controlling interest within the treasury to help ward off hostile takeovers.

Alternatively, treasury stock can be created when a company does a share buyback and purchases its shares on the open market. This can be advantageous to shareholders because it lowers the number of shares outstanding. However, not all buybacks are a good thing. For example, if a company merely buys stock to improve financial ratios such as EPS or P/E, then the buyback is detrimental to the shareholders, and it is done without the shareholders' best interests in mind

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Enterprise Value Vs Market Capitalization

Enterprise Value (“EV”) is the value of the company as of today, the present. It is calculated as Market Capitalization plus debt, minority interests and preferred shares, minus total cash and cash equivalents.  

Market Capitalization (“Market Cap”) is total market value of all of a company's outstanding shares (Outstanding Shares are stocks currently held by investors, including restricted shares owned by the company's officers and insiders, as well as those held by the public. Shares that have been repurchased by the company are not considered outstanding stock). Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share.

 EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm's value.To understand this consider a large multinational Chemical company acquiring another small chemical company. The acquirer will have to take the small company's debt and shall pocket its cash. The value of a firm's debt, for example, would need to be paid by the buyer when taking over a company, thus EV provides a much more accurate takeover valuation because it includes debt in its value calculation.

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