Perpetual finance

Does an issuer’s money stabilize its own quotation?

PZU to finance stabilization for…EUREKO

The principal journals – advertisers of the PZU offer - encouraged purchasing of the shares using favourable company pricing … queues for the reglamented stock, referring to well-informed sources on significant oversubscription and signalled that the price was likely to be higher for institutions etc. In this way, over 100 thousand “fresh investors” have been acquired. Numerous ways and all available channels of information distribution have been utilised to promote the offer.

EUREKO knew how to sell the goods to the general public and how to make use of the state mechanism in order for the operation to be a success. Without a shadow of a doubt, EUREKO has wide experience within the area of agreements and arrangements made in the shadows of ministerial offices.

Stabilization funded with PZU money

One of the elements of the puzzle, which was supposed to encourage purchasing PZU shares from EUREKO, was a stabilization option. The adopted solution provided an opportunity to buy-back PZU shares for a price not higher than that offered to institutional investors (312.5 PLN). The company may acquire up to a maximum of 2,590,569 shares, i.e., around 10% of the sale offer.

Investors selling some shares believe that a company is not worth a current market price or that the potential for its growth is insignificant compared with other investments. If – in the same time – a company buys back shares in order to redemption, then how will this impact on its value? In hindsight, if it turns out that it was the investors selling the shares, who were right and the market price drops, then how should one assess a company buying back shares in order to redemption?

One can say that regardless of the future price – a share buy-back programme took place and thereby conclude the assessment. It is interesting, however, to know how such buy-back impacts on the value of a company, when the shares were acquired at a higher price than the market value of the shares in the future.

Despite the transaction specifics, the company invested in something, which has a lower market price in the future. In hindsight, (assuming the share price will drop) one can determine that the company paid shareholders more for the potential on the market, by which the company reduced its activity, than the market has valued this potential in the future. Such transactions caused the remaining potential of the company (valued by the market) to be further reduced with regards to remaining shares not destined for buy-back, as compared to a situation in which no share-buy-back took place. Therefore, the share buy-back at a price, which turned out to be higher than future market valuation of the company shares, impacts on an additional drop in share value.

A different situation arises when the company share price increases in the future, in which case the earlier share buy-back results in an increased market share price.

The impact of share buy-back (at the market price) on future company share prices is therefore dependent on the forecast of share prices of a particular company without executing share buy-back. Should an investor become convinced that the aim of a buy-back is to defend the market price, then he certainly should not allow himself to be led by the temporary nature of such an operation – mainly psychological from his perspective, and a social engineering one from the point of view of those initiating the buy-back scheme – he should also bear in mind that executing such a scheme has an additional impact on the drop in the market price of shares in the future. By discounting the future, the investor should, at the time he acquires information on the scheme, accept the sale of shares at a lower price.

In practice, the most probable is a situation in which some resolute institutional investors shall assess share buy-back correctly and those who assume that without buy-back the share price will drop, shall include this in their assessment that with the stabilization programme the share price will drop more in the future and they will discount the expectations by selling their shares to other investors and the company (within the buy-back).

Sale of shares and new issue of shares within a stabilization scheme

In case of PZU, it is first and foremost EUREKO selling shares while the Treasury does the same albeit on a limited scale. Consequently, we have a simultaneous the sale of shares by the shareholders alongside PZU buy-back program that can be executed – called stabilization option. Shareholders are selling shares and the company is stabilizing the share price. This is a most curious solution. The investors should give themselves the answer as to the intention of the scheme.

Whereas in the case of share issue by a company, which is cashing the proceeds from the sale of shares, in order to fund the stabilization option executed by the emitting party, which can use part of the proceeds from sale of shares on the stabilization scheme, is of somewhat different dimension. While the necessity of implementing a stabilization scheme is to be evaluated by comparable criteria and investors should also ask themselves right after “the issue” and during the initial quotations what if- i.e. what share price they forecast in the future [independent of the buy-back scheme (because as can be seen the scheme itself is strengthening the tendency)] that the nature of such an operation would be different.

In case of share issue the psychological impact of a stabilization option and a possible “detrimental investment” in own shares would reduce the sale proceeds – the company would in real terms be repurchasing part of the issued shares within the share offer. This would be like taking money out from one pocket and putting it in the other, where both pockets are part of the one person’s clothing, and in the worst scenario, it would result in the reduction of cash proceeds from the issue.

One cannot hide the fact that the psychological impact of the buy-back scheme within a stabilization option is meaningful and may influence the effectiveness of the offer and the value of sale proceeds. From the issuer’s perspective, it may be worth attracting investors by telling them that a stabilization scheme has been established, in order to secure safety of their investments (in reality, from their own money – but this would not be stressed).

In the case of PZU’s share issue, enticing individual investors to purchase PZU shares from EUREKO and the Treasury at the highest price possible - while taking advantage of the company-financed stabilization option - does not translate itself in any obvious way into benefits for PZU. The high price of shares has a “here and now” meaning when shares are being issued by the company. Implementing a stabilization option that in the long-term may have a detrimental impact on the company’s market valuation, as signified by the nature of the stabilization option, in essence, a short-term defence mechanism from falling share price, mildly speaking is pointless.

If it is EUREKO and the Treasury selling shares, then perhaps EUREKO and the Treasury should finance the stabilization option? And, for example, 10-20 % of the proceeds from sale of shares should be designated for underpinning the share price. So, why do the gentlemen from EUREKO not agree to such a scheme, do they perhaps lack a little faith…

Jaroslaw Suplacz