Tender Offers: Take the Money and Run

Steve McDonald
by Steve McDonald, Bond Strategist, The Oxford Club

Tender Offers: Take the Money and Run

It isn’t often someone pays you more than they’re legally obligated to pay. But that’s exactly what’s happening more and more often in this bond market.

It’s called a “tender offer,” and since interest rates have dropped to record lows there have been a growing number of them, and they’ve worked out very nicely for the bondholders. They’re also one way to beat both the stock and bond market.

Here’s how a tender offer works.

Whenever a bond is issued, in this case a corporate bond, the company usually builds in safety valves for future use. These are used to save the company money on their debt obligations. These safety valves are called “call dates.”

Not to be confused with call options, bond calls are set dates when the company has the right to buy back a bond. These dates are always before maturity, at a set price, usually at a premium over par, and greater than $1,000 per bond.

In our current interest rate environment, lots of bonds are being called. It just makes sense to reissue or refinance a bond that was issued at a higher interest rate. The owner makes money and the company saves a ton of money on interest when they refinance at the current historic low rates.

Sometimes bond owners don’t see them as such a good deal. They may have a high coupon bond called that they might not have wanted to lose. But I say, take the money and run, it may not be there tomorrow.

“Free Money”

Never complain if someone is giving you free money.

Not all bonds have call dates, but in this rate environment, all bond issuers wish they did. So, when a company wants to get their high-cost bonds off the market and they can’t call them, they make a special tender offer – which is usually a really good offer – to buy back their bonds.

Sometimes it’s a great deal, sometimes it’s just ok. A lot depends on how much you paid for the bond. This is one of the many instances where my “buy at a discount” discipline comes in very handy.

The higher the coupon of the bond, the bigger the tender offer has to be to get owners of the bonds to sell them to the issuer. It’s just a matter of numbers; it costs more to buy back an 8% coupon bond before maturity than a 4% or 5% bond.

A Recent Example

Here’s a bond I recommended last year that has a current tender offer:

Cenveo – We bought it for around 98 in June of last year. This was one of those “pucker bonds.” It isn’t a well-known company, and for the average stock head, it wasn’t the best fit because it’s privately owned, and that sends up red flags all over the place for stock jockeys. They don’t trust companies that aren’t listed on the exchanges.

But bonds from privately owned companies pay more then public companies’ bonds and are just fine. More at another time on why privately owned companies’ bonds are good deals.

Our minimum expected annual return (MEAR) when we purchased the bond was around 9.46%. Not a huge return, but very respectable. But if the holders accept the current tender offer of 111, $1,110 per bond, they’ll make out like bandits.

We paid around 98 for the bond, $980, so just in capital gains we get $130 per bond, or 13.26%, in about nine months, plus our interest of 7.875%.

Oh, and accrued interest. I don’t usually talk about AI as it can be very confusing for the uninitiated, but in this case, it’s important.

When you own a dividend stock, you must own it on the ex-dividend date or you don’t get paid any interest for the preceding quarter. But with a bond, you’re paid from the moment the bond shows up in your account until it matures, you sell it, or in this case until the tender offer is paid.

So our real return was $130 in capital gains, plus an interest payment on December 1 of $39.37, plus AI for the period from December 1 to about April 1 in the amount of $26.35. (That’s an estimate for a holding period of about 10 months which gives us an annual return of 23.96%: $39.37 + $26.25 + $130 / 980/ 10 months x 12 = 23.96%.)

In any comparison, that’s a great return.

Take the Money and Run

Since interest rates dropped to their ridiculously low levels, tender offers have been coming out of the woodwork and bonds are being called and tendered at an unusually high rate. In almost all cases they’ve been great deals for the bond holders.

Still, many stockbrokers won’t buy bonds that can be called. They see the call as a negative. The same is true for tender offers. It’s rare a stockbroker will advise their clients to accept a tender offer. They view it as a loss if they give up a high coupon bond.

But, that’s why they’re called stockbrokers and not bond brokers. They have a much greater understanding of stocks than bonds.

Tenders and calls are one of the best ways to beat this market. If someone is willing to pay you more than they have to, take the money and run.

Good Investing,

Steve McDonald

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