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Share repurchases – The type of arrangement matters · PwC's accounting podcast

• 0:00
  SPEAKER_02: Thought leadership from PWC's national office.
• 0:06
  SPEAKER_01: Welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_01: I'm Heather Horn.
• 0:11
  SPEAKER_01: Today we kick off a new group of accounting podcasts focusing on topics from our financing transactions guide.
• 0:18
  SPEAKER_01: In this first episode, we cover sharep purchases and treasury stock.
• 0:22
  SPEAKER_01: This is one of the most popular guides and one of the most popular sections of the guide.
• 0:27
  SPEAKER_01: So hopefully you'll find this interesting to you.
• 0:30
  SPEAKER_00: There's really only two ways that a company can return cash to its shareholders.
• 0:35
  SPEAKER_00: The first way is to pay dividends, and the second way is through share repurchases.
• 0:39
  SPEAKER_00: And many corporate finance theorists and tax advisors believe that the more tax-efficient way to return cash to shareholders is through share repurchases.
• 0:50
  SPEAKER_00: So that's that's a major reason.
• 0:57
  SPEAKER_01: That was John Haran, a managing director in PWC's national office.
• 1:02
  SPEAKER_01: His years of experience helping clients and engagement teams with complex accounting questions in this area.
• 1:08
  SPEAKER_01: John's great at helping break down the topic to make it easier to understand.
• 1:12
  SPEAKER_01: With that, let's kick off the mini-series.
• 1:15
  SPEAKER_01: John, welcome back to the podcast.
• 1:17
  SPEAKER_01: And thank you so much for kicking off our month focused in on financial instruments and financing topics.
• 1:23
  SPEAKER_01: And in particular today, talking about share repurchases and treasury stock.
• 1:27
  SPEAKER_01: So I think it may be helpful before we start to get into some of the detail about some of the accounting, why we're seeing some of these transactions and in particular with stock repurchases, why a company may want to repurchase their shares.
• 1:42
  SPEAKER_00: Sure.
• 1:42
  SPEAKER_00: You know, first thing, Heather, I thought we talked about is, you know, corporate share repurchases remain a key financial strategy for many companies.
• 1:50
  SPEAKER_00: In 23, we actually saw a decline in share repurchases.
• 1:55
  SPEAKER_00: That may have had something to do with the fact that corporate profits were down in the first two quarters, quarters of 23.
• 2:02
  SPEAKER_00: Um, another thing that happened from a regulatory perspective, the Inflation Reduction Act was issued in August of 22.
• 2:08
  SPEAKER_00: I know you know a lot about it.
• 2:10
  SPEAKER_01: Yes, it's one of my favorite topics.
• 2:11
  SPEAKER_01: I perked right up.
• 2:13
  SPEAKER_00: And part of the Inflation Reduction Act, uh, a 1% excise tax was put in place on share repurchases.
• 2:20
  SPEAKER_00: So my my guess is that that had something to do with the decline.
• 2:24
  SPEAKER_00: People wanted to figure out what that was all about.
• 2:26
  SPEAKER_00: Yes, I think.
• 2:27
  SPEAKER_00: Um, in addition to that, um, sharebacks haven't been a really popular thing for companies to do among politicians.
• 2:36
  SPEAKER_00: Um, from a political perspective, it's not necessarily positively viewed.
• 2:41
  SPEAKER_00: Um, and um as a result of that, I think the SEC in May of 23 has instituted some new disclosure requirements around um share repurchases.
• 2:52
  SPEAKER_00: So despite all of that, we still do see share repurchases um happening.
• 2:57
  SPEAKER_00: Um beginning of this year, first quarter of this year, many of the analysts were predicting a recovery from the you know, the waning of share repurchases in 23.
• 3:07
  SPEAKER_00: So I, you know, I guess that remains to be seen.
• 3:10
  SPEAKER_01: Well, and John, I think it's interesting when you talk about a rebound in 2024, because we saw with that SEC rule that was issued in May, then there was litigation, and then ultimately we saw that it has not become effective.
• 3:24
  SPEAKER_01: And so when we think about a rebound in 2024, there's a lot of different pieces that potentially are uh impacting that.
• 3:32
  SPEAKER_00: Yeah, yeah.
• 3:32
  SPEAKER_00: And and including, you know, how companies are performing in 24 as well.
• 3:36
  SPEAKER_00: I think fair enough, fair enough.
• 3:38
  SPEAKER_01: So then if we take a step back and okay, so move past the what's going on from a broader environmental perspective.
• 3:45
  SPEAKER_01: If I'm in a company, what are some of the reasons that I may want to move forward with a share repurchase?
• 3:52
  SPEAKER_00: I I think some of the primary reasons are there there's really only two ways that a company can return cash to its shareholders.
• 3:58
  SPEAKER_00: The first way is to pay dividends, and the second way is through share repurchases.
• 4:02
  SPEAKER_00: And many corporate finance theorists and tax advisors uh believe that the um more tax-efficient way to return cash to shareholders is through share repurchases.
• 4:14
  SPEAKER_00: So that's that's a major reason.
• 4:16
  SPEAKER_00: Um the other is you know, by pulling shares out of your share can you increase um earnings per share and dilution of the stock, which can you know positively impact a company's stock price.
• 4:30
  SPEAKER_00: Um another reason is especially for companies that have significant stock compensation plans, um option plans, where shares are getting issued as compensation to executives and employees, um, many times share repurchases are used to offset the dilution that company incurs as a result of those plans.
• 4:49
  SPEAKER_00: Um and finally, um, having been a finance major in graduate school, um a very important reason is to optimize a company's capital structure.
• 4:59
  SPEAKER_00: So the CFO and the treasurer of a company normally have a view as to what the optimal, it's usually a range, but the optimal capital structure of a company looks like in terms of how much debt and how much equity.
• 5:11
  SPEAKER_00: And so share repurchases can be used to tweak that optimal, you know, the the capital structure to the point that they believe is optimal.
• 5:19
  SPEAKER_01: It's interesting though, John, when I think back to the sort of broader environment we were talking about and that these are less popular from a political perspective, it's because they would rather see that capital being deployed in some other way rather than just buying the company's own shares.
• 5:34
  SPEAKER_00: Yeah, absolutely.
• 5:35
  SPEAKER_00: I mean, certainly, you know, they they they believe there's some companies that buy back shares um at the um to the negative impact to employees and things like that.
• 5:44
  SPEAKER_00: Um, that's the that's the thought process.
• 5:46
  SPEAKER_00: You know, I would say the ones I just mentioned are probably the primary reasons, but you know, many companies, you know, many C-suites look at it and say, hey, share repurchases send a signal to the market that we're high on our stock, you know, that we think it's undervalued.
• 5:57
  SPEAKER_01: Yeah.
• 5:58
  SPEAKER_00: And to a lesser extent, they can be used to help prov present hostile takeovers.
• 6:03
  SPEAKER_00: Not we don't see too many of those anymore.
• 6:05
  SPEAKER_00: Though, you know, the cowboy days of the 80s are gone, I guess.
• 6:08
  SPEAKER_00: But um uh and then, you know, repurchasing shares from major stockholders, those types of things are also out there.
• 6:15
  SPEAKER_01: So I know that there's a lot of different ways companies can sort of enact a share repurchase program.
• 6:19
  SPEAKER_01: What are some of the sort of typical uh ways we do see that?
• 6:24
  SPEAKER_00: A lot of the there there are four or five, six different ways that uh that companies do share repurchases, and a lot of this has to do with um laws and and regulations around um the share repurchases.
• 6:35
  SPEAKER_00: Some of them have developed to help companies alleviate some of the risk when they go out and buy um their own shares in the market.
• 6:42
  SPEAKER_00: Um, a couple of things about share repurchases.
• 6:44
  SPEAKER_00: First thing is a company needs to get approval from their board of directors to do it.
• 6:47
  SPEAKER_00: And typically they'll go get a resolution of the board.
• 6:50
  SPEAKER_00: It typically sounds something like um we authorize the company to repurchase$300 million in shares over the next 18 months.
• 6:58
  SPEAKER_00: And then management of the company is free to go and figure out exactly how they're going to do that.
• 7:04
  SPEAKER_00: Um, in addition, you know, when a company engages in repurchase of its own shares, they have to act in good faith, right?
• 7:11
  SPEAKER_00: And so there are some rules and laws.
• 7:14
  SPEAKER_00: I'm no lawyer, although um sometimes I feel like one, um, but I'm I'm not a lawyer.
• 7:19
  SPEAKER_00: But there are there are um rules around when and how a company can repurchase their shares.
• 7:25
  SPEAKER_00: Um and as a result, there are certain safe harbors that exist.
• 7:30
  SPEAKER_00: And in order, you know, the you know, the rules around the safe harbors, you know, contain certain conditions.
• 7:35
  SPEAKER_00: Those conditions include the manner in which the repurchases are conducted, the timing of the repurchases, the daily volume of the repurchases, um, and of course the price at which you know those repurchases occur.
• 7:49
  SPEAKER_00: And so as a result of that, there are different um plans and processes that have developed.
• 7:55
  SPEAKER_00: I think uh a very common one and um something we see quite a bit is just plain vanilla spot repurchase the company's shares, right?
• 8:04
  SPEAKER_00: And in in this case, company just has a you know, has a broker.
• 8:09
  SPEAKER_00: Um, they put somebody so put somebody internally in charge of you know making sure they're complying with the rules and regulations.
• 8:17
  SPEAKER_00: And uh that person makes a decision, this is a good time to buy our shares or a bad time to buy our shares.
• 8:23
  SPEAKER_00: Pick up the phone, similar to the way you and I would with our personal uh broker.
• 8:27
  SPEAKER_00: Pick up the phone, call the broker, and execute um a trade in their own stock.
• 8:32
  SPEAKER_01: Oh, this sounds like it could easily run into some pitfalls, but uh anyway, keep going and we'll talk about that conning occasion.
• 8:39
  SPEAKER_01: Let's assume they execute it in accordance with all the required tier point regulations.
• 8:44
  SPEAKER_00: You know, I would say you should be fairly experienced at this.
• 8:46
  SPEAKER_00: Yeah.
• 8:48
  SPEAKER_00: But it it happens, we do say it.
• 8:50
  SPEAKER_00: And um secondly, is one of these plans that would qualify you for a safe harbor.
• 8:56
  SPEAKER_00: It's called a 10B51 safe harbor plan.
• 9:00
  SPEAKER_01: All right.
• 9:00
  SPEAKER_01: Importance remember sexy name.
• 9:02
  SPEAKER_00: Yes.
• 9:03
  SPEAKER_00: Um, but what it means is I'm gonna go to my broker or my investment bank, I'm gonna establish a plan uh with a formula and a dollar amount for them to purchase stock over some period of time, call it three months.
• 9:16
  SPEAKER_00: And we'll give them a plan and a formula that says buy your shares given these circumstances.
• 9:21
  SPEAKER_00: We give it to them contractually, the plan is irrevocable.
• 9:24
  SPEAKER_00: Um, and the broker goes out and executes the trades.
• 9:28
  SPEAKER_00: Now, typically it would be for a dollar, and we may go to that broker and say it's gonna, you know, we want to buy a hundred million dollars of shares pursued to these parameters over three months.
• 9:38
  SPEAKER_00: And the broker will go out and pay attention to what those parameters are, but it's not solidified in stone that they'll actually purchase stairs because the parameters may never be met.
• 9:47
  SPEAKER_00: But it does protect the company from some of those compliance issues that we talked about.
• 9:52
  SPEAKER_00: Not all of them, but some of them.
• 9:53
  SPEAKER_00: Yeah, another way to do it is just a plain old forward repurchase contract.
• 9:58
  SPEAKER_00: So you go to an investment bank, you enter into a trade with the investment bank to repurchase your your um shares, or it could be other than a uh I'm an investment bank as well, could be a major shareholder.
• 10:09
  SPEAKER_00: And we're gonna repurchase these shares over some period of time uh in the future.
• 10:14
  SPEAKER_00: So that's another way that we see companies do it.
• 10:16
  SPEAKER_00: There's also, this is probably a less common item, but we we see it, and it's a self-tender offer.
• 10:23
  SPEAKER_00: So the company can go out and make a tender offer for their own shares in the market broadly to their shareholder group and repurchase their own shares that way.
• 10:33
  SPEAKER_00: And finally, this one gets a lot of press in the accounting world, and it's called an accelerated share repurchase plan.
• 10:41
  SPEAKER_00: An accelerated share repurchase plan is basically a plan typically executed through an investment bank where we go to the investment bank and legally what the contract says, um, and we'll talk about the accounting later, but legally what the contract says is you know, we'll give you a hundred or two hundred or three hundred million dollars today.
• 11:01
  SPEAKER_00: You're going to deliver a stipulated amount of shares based on the stock price on the day we enter into that contract today or tomorrow.
• 11:08
  SPEAKER_00: And then we'll settle up on that based on the average price of our stock over the period of the contract.
• 11:15
  SPEAKER_00: That contract, I mean, I would say typically they're one to three months, um, but in particularly large deals, they can be six months or nine months.
• 11:25
  SPEAKER_00: And um, it also depends on the liquidity of the stock because you know, only so many shares, you're only allowed to purchase so many shares of your stock in a day, and if the investment bank is out there buying shares.
• 11:36
  SPEAKER_00: So those are the primary ways.
• 11:39
  SPEAKER_00: Um, there may be others that companies go about it.
• 11:43
  SPEAKER_01: So, John, I think part of the reason it's important to understand the way is because they do have accounting implications depending on the approach you've taken.
• 11:51
  SPEAKER_01: Am I correct?
• 11:53
  SPEAKER_01: Absolutely.
• 11:53
  SPEAKER_01: All right.
• 11:54
  SPEAKER_01: So why don't then we walk through each of them a bit further?
• 11:58
  SPEAKER_01: And I mean, we can start with one almost, excuse me, uh the heebie-jeebies because of the number of things that could go wrong.
• 12:05
  SPEAKER_01: But this idea of the spot repurchases within um, you know, the company itself executing on that.
• 12:12
  SPEAKER_00: Think about the way when you you know you call your own broker to execute a trade.
• 12:16
  SPEAKER_00: I don't know, you look in, you say, I like this stock.
• 12:18
  SPEAKER_00: Yeah, pick up the phone, you know, can you buy me the stock?
• 12:21
  SPEAKER_00: I like it at$20.
• 12:24
  SPEAKER_00: Broker says, okay, you know, we'll see if we can do it.
• 12:27
  SPEAKER_00: He goes out, does whatever he has to do in the market to see if he can buy it at$20.
• 12:30
  SPEAKER_00: He calls you back and says, All right, you're done at$20.
• 12:33
  SPEAKER_00: And then the trade settles three days later, two to three days later.
• 12:36
  SPEAKER_00: Yeah.
• 12:36
  SPEAKER_00: I think it used to be three days, it's two days later.
• 12:38
  SPEAKER_00: I think it's now two days, yeah.
• 12:39
  SPEAKER_00: Um, so same thing for a company doing a spot repurchase.
• 12:42
  SPEAKER_00: Pick up the phone, call the broker.
• 12:44
  SPEAKER_00: I want to buy my own, you know, X amount of my own shares at this price.
• 12:48
  SPEAKER_00: Broker calls them back, calls he or she back and says, okay, you're done at you know,$20,$30,$40, whatever the price of the stock is.
• 12:56
  SPEAKER_00: And then two days from now, I deliver cash and um he did, you know, they deliver shares.
• 13:01
  SPEAKER_00: So if you think about that, what that really is is a forward purchase contract.
• 13:06
  SPEAKER_01: Yes, a very short one.
• 13:07
  SPEAKER_00: A very short one, yes, but it's a forward purchase contract.
• 13:10
  SPEAKER_00: So we would say, you know, we get a lot of calls.
• 13:13
  SPEAKER_00: Hey, we just did this spot repurchase.
• 13:15
  SPEAKER_00: Should we account for it on trade date or settlement date?
• 13:18
  SPEAKER_00: Tell me about the trade.
• 13:19
  SPEAKER_00: Yes.
• 13:19
  SPEAKER_00: And if it's the trade I just described, we have a contractual obligation to deliver a fixed amount of cash for a fixed amount of shares in two days.
• 13:28
  SPEAKER_00: Sounds like a forward purchase contract to me.
• 13:30
  SPEAKER_00: Yeah, right.
• 13:31
  SPEAKER_00: Um, so the accounting for that, um, there's a special accounting in in ASC 480 for repurchase of your own shares, where it's a fixed dollar amount, fixed price, payable in cash, unconditional on a fixed date.
• 13:46
  SPEAKER_00: And that is we're basically going to assume we repurchase the stock today for a liability.
• 13:52
  SPEAKER_00: And um, so that's the accounting for that trade.
• 13:55
  SPEAKER_00: We would debit equity, credit, liability for the discounted amount of that liability, and then we'd accrete interest over that two or three day period.
• 14:06
  SPEAKER_00: Now, I don't know that anybody gets too excited about that, but that's you know technically the accounting for that trade.
• 14:12
  SPEAKER_01: But so then in the end, sort of the net impacts, then you settle your liability.
• 14:17
  SPEAKER_01: So ultimately, you are winding up with a debit in your equity and a reduction in cash, basically.
• 14:25
  SPEAKER_01: All right.
• 14:26
  SPEAKER_01: So that's the first one.
• 14:28
  SPEAKER_01: And then from a practical point of view, unless that's happening like one day before the end of the period or two days before the end of the period, it really wouldn't have a big accounting impact.
• 14:41
  SPEAKER_01: Is that fair?
• 14:42
  SPEAKER_00: It's true.
• 14:42
  SPEAKER_00: You would just the only thing would be the interest amortization, which on a two-day contract is probably not a boatload unless it's a really, really big trade.
• 14:51
  SPEAKER_01: Yes, unless there's a really big trade.
• 14:52
  SPEAKER_00: Yeah, absolutely.
• 14:53
  SPEAKER_00: But believe it or not, I we do see situations where it happens over over a yeah.
• 14:57
  SPEAKER_00: Over the period.
• 14:58
  SPEAKER_01: And then in which case it's important to get the accounting.
• 15:01
  SPEAKER_01: I mean, always important to get the accounting right, but particularly important um over the end of a period.
• 15:07
  SPEAKER_01: So then let's move on then to the ones that were more systematized with the fancy name, the 10B5-1 plans.
• 15:16
  SPEAKER_00: Yeah, again, this is a you know, we're we've given the um broker of the investment bank some instructions to execute trades according to per certain parameters.
• 15:24
  SPEAKER_00: We have given a dollar amount.
• 15:25
  SPEAKER_00: We want to buy a hundred million dollars share a hundred million shares.
• 15:28
  SPEAKER_00: And so when I get a call and they they start saying, hey, we're we we're repurchasing shares, I I start asking questions like, well, tell me about the plan.
• 15:36
  SPEAKER_00: You know, and you know, many times it's one of these plans.
• 15:40
  SPEAKER_00: And so they says, should we be debiting equity and crediting liability for$100 million?
• 15:45
  SPEAKER_00: Because that's well, no.
• 15:47
  SPEAKER_01: You haven't done anything yet.
• 15:50
  SPEAKER_00: Wait till the broker calls, tells you that he's executed a trade.
• 15:54
  SPEAKER_00: At that point in time, it's very it's the same thing as the spot trade.
• 15:58
  SPEAKER_00: Are we unconditionally obligated to deliver cash in two or three days for a fixed number of shares on a on that fixed date two or three days from now?
• 16:07
  SPEAKER_00: The answer to that question is yes.
• 16:08
  SPEAKER_00: You know, then we debit equity at that time, credit liability.
• 16:11
  SPEAKER_00: So that's going to be staggered for the reason you said we may never get executed if the parameters are never met.
• 16:17
  SPEAKER_00: So it's very similar accounting to the first one, but you've got the protections of Yes, making sure that someone else is making sure you comply with all these requirements.
• 16:26
  SPEAKER_01: So then how about then the forward repurchase plans?
• 16:29
  SPEAKER_01: This is the ones I think that you said are also more exciting from an accounting point of view.
• 16:34
  SPEAKER_00: Yeah, I mean, a forward repurchase, you know, again, the spot trade is a forward repurchase.
• 16:39
  SPEAKER_00: So if we have a forward repurchase, again, that's that's just a longer period of time, let's say it's a month down the road or two months down the road, um, it's the same accounting.
• 16:48
  SPEAKER_00: The only difference is more likely to cross over a quarter end, and that discount that gets created is going to be more significant.
• 16:57
  SPEAKER_00: But essentially the accounting is the same for those trades.
• 17:00
  SPEAKER_00: Now, they're not all that clean.
• 17:03
  SPEAKER_00: Of course not.
• 17:05
  SPEAKER_01: We wouldn't be having this podcast.
• 17:08
  SPEAKER_00: So um, if you've got a physically settled forward contract, the first question is is it fixed price, fixed date, cash?
• 17:16
  SPEAKER_00: Right?
• 17:16
  SPEAKER_00: If it is, we're in the model that I just spoke about.
• 17:19
  SPEAKER_00: Right?
• 17:20
  SPEAKER_00: So we're talking about initial recognition.
• 17:23
  SPEAKER_00: If it's other than that, let's say it's fixed number of shares, but the date isn't fixed or the price isn't fixed for whatever reason.
• 17:31
  SPEAKER_00: What the standard, but it still has to be physically settled, right?
• 17:35
  SPEAKER_00: And it's unconditional it's going to happen.
• 17:37
  SPEAKER_00: Right.
• 17:38
  SPEAKER_00: We would still debit equity credit liability, but the met the subsequent measurement of that instrument would be different than you know just accreting over a period of time.
• 17:50
  SPEAKER_00: What we would do is at the end of every reporting period, we would say, let's assume this is the settlement date of the instrument.
• 17:56
  SPEAKER_00: How much would I have to pay if today was the settlement date of that instrument?
• 18:01
  SPEAKER_00: And that's what I record my liability to.
• 18:03
  SPEAKER_00: And the difference between reporting periods goes to interest cost.
• 18:07
  SPEAKER_00: So that's if it's physically settled, unconditional, settlement date varies or price varies.
• 18:14
  SPEAKER_00: Okay.
• 18:15
  SPEAKER_00: Now, we also see contracts that are net cash or net share settled.
• 18:21
  SPEAKER_00: Um, so that means we don't definitely know that shares are coming, you know, all the shares underlying the contract are coming back.
• 18:29
  SPEAKER_00: Net cash settled means, you know, the counterparty could just settle up by giving us cash or us giving them cash.
• 18:36
  SPEAKER_00: Um, net share settled is the same thing, except it's a variable number of shares equal to the intrinsic value of that contract.
• 18:44
  SPEAKER_00: And so in those cases, the initial recognition for the contract would be fair value, and subsequent measurement would also be fair value with changes in fair value through earnings, derivative-like accounting.
• 18:57
  SPEAKER_01: So then how about another scenario I think we would see, which would be this prepaid that you talked about, where so basically you are paying now for something that's going to happen in the future.
• 19:09
  SPEAKER_00: Yeah, we we this is just a forward purchase contract.
• 19:12
  SPEAKER_00: One different instead of being postpaid, we you know, let's just say it's four a month from now or two months from now, instead of being postpaid, we prepaid the exercise price.
• 19:22
  SPEAKER_00: Why would a company do that?
• 19:23
  SPEAKER_00: Well, it gets you out of 480.
• 19:25
  unknown: Yeah.
• 19:27
  SPEAKER_01: Okay.
• 19:29
  SPEAKER_01: Which we know is complicated.
• 19:31
  SPEAKER_00: So so the reason that you get out, because um 480, you know, in that situation, all that's going to happen is we're just sitting there waiting with the catcher submit for shares to come back.
• 19:41
  SPEAKER_00: Right.
• 19:42
  SPEAKER_00: Right?
• 19:42
  SPEAKER_00: There's no obligation of the company.
• 19:44
  SPEAKER_00: We've already prepaid the contract.
• 19:47
  SPEAKER_00: And so we we would not be a liability under 480.
• 19:51
  SPEAKER_00: However, one would look at that and say that, well, isn't that really a loan with an embedded forward purchase contract?
• 19:59
  SPEAKER_00: And so you need to run the forward purchase contract through a 1540, which I know we just finished another podcast telling everybody all about that.
• 20:07
  SPEAKER_01: Yes.
• 20:08
  SPEAKER_00: Um, but assuming you passed through, and many of these trades we do do pass, um, they they're intended to, and uh so assuming you pass through 480, we would say, well, the substance of this transaction is a treasury stock transaction, and therefore the asset that we've created by prepaying the um exercise price can get classified in equity.
• 20:31
  SPEAKER_01: All right.
• 20:31
  SPEAKER_01: So then all of those have sort of I'll say similar implications, but then how about let's go down the one you said you don't see very often, but this tender offer, what are the accounting implications of that?
• 20:43
  SPEAKER_00: The tender offers are very, very highly regulated transactions.
• 20:49
  SPEAKER_00: And because that's because the SEC wants to make sure that all shareholders are being treated fairly.
• 20:54
  SPEAKER_00: There are lots of rules around tender offers.
• 20:57
  SPEAKER_00: And we see tender offers um, you know, we have clients, you know, that are that are US registrants, we have clients that are publicly traded in other countries' markets, or subsidiaries that are traded in other countries' markets.
• 21:11
  SPEAKER_00: The rules are different between countries.
• 21:14
  SPEAKER_00: Very important to understand the rules.
• 21:16
  SPEAKER_00: But in the US, you know, there's some rules.
• 21:18
  SPEAKER_00: One of the rules is that tender offer has to be outstanding for 20 days.
• 21:22
  SPEAKER_00: Um, there are others, you know, but and they're all designed to make sure that all shareholders are treated fairly.
• 21:28
  SPEAKER_00: Again, I'm not a lawyer, but I do know that that exists.
• 21:30
  SPEAKER_00: Yes.
• 21:31
  SPEAKER_00: The key in a tender offer is understanding when when the company, you know, they have rules around, you know, when they announce it, how they announce it, you know, how it gets communicated.
• 21:43
  SPEAKER_00: How it's communicated, things like that.
• 21:45
  SPEAKER_01: Yes.
• 21:45
  SPEAKER_00: But once that's done, the key is understanding what are the obligations of the company that's making the tender, and what are the obligations of the shareholder who's the recipient of the tender offer.
• 21:57
  SPEAKER_00: So for example, if the company was Was unconditionally obligated after making the offer to repurchase shares, assuming they were tendered by the investor.
• 22:07
  SPEAKER_00: But the investor is not obligated to tender.
• 22:11
  SPEAKER_00: Sounds a lot like a written put, doesn't it?
• 22:13
  SPEAKER_00: Right.
• 22:14
  SPEAKER_00: You know, so we've obligated ourselves to repurchase the shares, but the investor is not obligated.
• 22:20
  SPEAKER_00: And so a written put under ASC 480 is an instrument that needs to be marked to market.
• 22:26
  SPEAKER_00: It's also important to understand.
• 22:28
  SPEAKER_00: Usually the tender offer rules state that that investor, you know, let's just say the tender offer period is 20 days or 30 days.
• 22:37
  SPEAKER_00: It has to be a minimum of 20, is my understanding.
• 22:39
  SPEAKER_00: The investor can say on day one, okay, I'm going to tender my shares, but he or she is not normally obligated until very, very close to the actual tender close date.
• 22:50
  SPEAKER_00: He or she or she can withdraw that tender offer very up until very, very close, might be a day or two before the tender is due to close.
• 23:01
  SPEAKER_00: Typically, that investor is not obligated for that period of time.
• 23:06
  SPEAKER_00: We do see arrangements, however, where um for various reasons, one investor may obligate themselves for for whatever to do it.
• 23:16
  SPEAKER_00: You know, we've seen you know lots of different variations.
• 23:19
  SPEAKER_00: So you do need to understand all of the legal details around these trades and understand do I have a written put, do I have a forward purchase contract, or do I have nothing?
• 23:30
  SPEAKER_00: And um, you know, we do see tender offers where we have seen tender offers where the um material adverse change clauses are you know pretty broad or allow people to get out of those trades.
• 23:46
  SPEAKER_00: Um and we've seen other situations where um it appeared that the issuer was or the the company was obligated.
• 23:54
  SPEAKER_00: So um very, very important to go through all the legal details in those tender offers.
• 23:59
  SPEAKER_01: All right, I think that's the theme.
• 24:00
  SPEAKER_00: And conversations with lawyers.
• 24:02
  SPEAKER_01: Yeah, yeah.
• 24:03
  SPEAKER_01: Make sure you involve lawyers and just don't rely on what John is telling you in this podcast.
• 24:08
  SPEAKER_01: So then you mentioned this last type, the accelerated share repurchase, there is maybe, quote, more exciting from an accounting perspective.
• 24:16
  SPEAKER_01: So how would we think about those?
• 24:19
  SPEAKER_00: Yeah, these are you know very popular for for a couple of reasons.
• 24:24
  SPEAKER_00: You know, the first reason is when you enter into, remember, this is the contract we enter into where legally what we've got is a contract to purchase a fixed dollar, usually a fixed dollar amount number of shares over a period of time at the average price for the period.
• 24:40
  SPEAKER_00: From an accounting perspective, we break that into two transactions.
• 24:44
  SPEAKER_00: Normally there's a delivery of shares on day one or the day or immediately after we execute the trade.
• 24:50
  SPEAKER_00: Um, so those shares come out of share count immediately.
• 24:54
  SPEAKER_00: And secondly, if you're if you're a treasurer and you're worried about how successful you're going to be in repurchasing shares at a reasonable price, this guarantees you that you're going to get the shares over that period of time for the average price of the volume weighted average price over the stock.
• 25:10
  SPEAKER_00: That's attractive to a lot of um uh a lot of treasurers.
• 25:14
  SPEAKER_00: So in fact, the investment banks you know can structure the transactions such that you actually are guaranteed to do a little bit better than the average price over the period of time.
• 25:24
  SPEAKER_00: And you do that by writing certain options to the investment bank in that trade.
• 25:30
  SPEAKER_00: But if my objective as a treasurer is to you know repurchase the shares at better than the average price over that period, I just guaranteed it.
• 25:39
  SPEAKER_00: Right.
• 25:39
  SPEAKER_00: So that's why I think it's it's um a popular trade, you know, amongst you know, corporate finance folks.
• 25:46
  SPEAKER_01: So then, John, if you have all these other features that are included, then the accounting must have some additional complexity.
• 25:54
  SPEAKER_00: It it it does.
• 25:55
  SPEAKER_00: Um, it does create some complexity.
• 25:58
  SPEAKER_00: You know, like I said, this is is broken up into two trades, right?
• 26:02
  SPEAKER_00: So let me tell you what a typical ASR looks like that we see, the most common is um company decides they want to repurchase$100 million worth of shares.
• 26:13
  SPEAKER_00: So they execute the trade with an investment bank.
• 26:16
  SPEAKER_00: It's gonna be for two months, let's say, and the investment bank delivers to them a number of shares on the immediately after execution.
• 26:25
  SPEAKER_00: Typically 80 to 90 percent of the shares they would get for$100 million at the spot price on the day they entered into the trade.
• 26:33
  SPEAKER_00: We refer to those as holdback shares.
• 26:35
  SPEAKER_00: Okay, right?
• 26:36
  SPEAKER_00: So the 80% of the shares that we get, we account for that just as a treasury trans transaction.
• 26:41
  SPEAKER_00: Um we debit treasury stock, right, for the amount uh uh the uh fair value of the shares, which is you know the price on the day that we executed the trade.
• 26:50
  SPEAKER_00: The next part of the trade is a little more complicated, right?
• 26:53
  SPEAKER_00: Because of those holdback shares, right, we've got an interesting, very complex derivative.
• 26:59
  SPEAKER_00: And basically what that derivative is, it's a forward sale on the entire notional of the contract versus VWAP over that two-month period and a prepaid forward purchase on the holdback shares, all mashed together in one big ugly derivative.
• 27:17
  SPEAKER_00: Yes.
• 27:18
  SPEAKER_00: And so the accounting, you know, for this requires us, unfortunately, we're back in our good friend ASC 480.
• 27:25
  SPEAKER_00: What why do we need to think about this under 480?
• 27:27
  SPEAKER_00: Well, because even though, you know, the likelihood that stock price will increase to a level that we would have to um effectively deliver shares to the investment bank to settle the transaction, probably very unlikely given that we held back 10 or 20% of the shares, right?
• 27:44
  SPEAKER_00: Most likely we're gonna get shares.
• 27:46
  SPEAKER_00: But if the stock price does increase, it's possible we could have to deliver a variable number of shares to the investment bank.
• 27:54
  SPEAKER_00: And a forward purchase contract um has a payoff profile where the obligation of the um company is inversely related to its stock price.
• 28:04
  SPEAKER_00: So, in other words, my obligation increases if the stock price goes down.
• 28:09
  SPEAKER_00: That's a bad guy.
• 28:10
  SPEAKER_01: Exactly.
• 28:12
  SPEAKER_00: Right.
• 28:13
  SPEAKER_00: So we have to do a predominance test on that.
• 28:16
  SPEAKER_00: And so if that, if the forward purchase aspect of that contract is predominant, you know, that that complex derivative would be an asset or a liability.
• 28:26
  SPEAKER_00: In my example, it'd likely be an asset.
• 28:28
  SPEAKER_00: Okay.
• 28:28
  SPEAKER_00: But and it would be mark to market.
• 28:30
  SPEAKER_00: The reality is, even though you have to go through that pain of doing the predominance test, most of the time um the forward sale aspect of the derivative is more predominant than the um forward purchase contract.
• 28:44
  SPEAKER_00: So you typically don't get caught in 480.
• 28:46
  SPEAKER_01: Okay.
• 28:46
  SPEAKER_00: Although I've seen it get close.
• 28:48
  SPEAKER_01: Um close is not the same as actually happening.
• 28:52
  SPEAKER_01: Exactly.
• 28:53
  SPEAKER_00: Um so the second part of the analysis is we got to go into ASC 81540.
• 28:59
  SPEAKER_00: Because we're a public company, shares underlying this transaction this derivative are publicly traded shares readily convertible to cash.
• 29:07
  SPEAKER_00: We're gonna meet the definition of a derivative, right?
• 29:10
  SPEAKER_00: So we gotta determine whether we can get the own stock scope exception.
• 29:14
  SPEAKER_00: And so I know we just did a whole podcast on this.
• 29:18
  SPEAKER_00: Um, but that analysis requires to determine whether this contract is indexed to our own stock and whether it passes all the criteria that we need to think about in terms of whether it should be classified in equity.
• 29:30
  SPEAKER_00: And, you know, we see contracts um that have provisions in them that would cause us to say that the contract is not indexed to its own stock.
• 29:40
  SPEAKER_00: So I do think we said this in the last podcast, it's important to have experienced eyes look at these transactions.
• 29:47
  SPEAKER_01: Yes, definitely.
• 29:48
  SPEAKER_01: I mean, it's very, definitely very complex.
• 29:50
  SPEAKER_01: So then, John, let's presume you've listened to the other podcasts, you made it through, and now you have equity classifications.
• 29:58
  SPEAKER_01: Uh so what are the next steps?
• 30:00
  SPEAKER_00: Yeah, so it's it's interesting.
• 30:02
  SPEAKER_00: You know, think about the day one accounting first on our in my example where it was a hundred million dollar trade.
• 30:08
  SPEAKER_00: I know the credit, that's easy.
• 30:10
  SPEAKER_00: Credit cash for$100 million.
• 30:12
  SPEAKER_00: I'm gonna debit treasury stock for the 80% of the shares, fair value of the 80% of the shares I receive.
• 30:18
  SPEAKER_00: The other debit, assuming I get through 815.40, is to equity.
• 30:23
  SPEAKER_00: So my derivative, my complex derivative is gonna get equity classification.
• 30:28
  SPEAKER_00: Day two, the most likely scenario is I'm gonna receive shares from the investment bank.
• 30:33
  SPEAKER_00: Again, I'm gonna record those shares at the fair value on the on the day they're received, and I'm gonna credit equity.
• 30:39
  SPEAKER_01: All right.
• 30:39
  SPEAKER_01: So then, John, let's assume whatever route we took, we now have the shares.
• 30:45
  SPEAKER_01: So, how do we account for our treasury stock?
• 30:47
  SPEAKER_00: There's a couple of different ways that we can account for our treasury stock.
• 30:51
  SPEAKER_01: Of course.
• 30:52
  SPEAKER_01: It can't be straightforward if it's one of these topics.
• 30:56
  SPEAKER_00: So um the first thing is you really need to consult legal counsel, but one of the most common ways the companies account for treasury stock, when they receive the shares, they debit an account, treasury stock, and in their balance sheet, they just show it net for the amount that they paid for those shares in stockholders' equity.
• 31:13
  SPEAKER_00: And the caution I would say there is, you know, and again, you really need to speak with legal counsel because there are states, depending on what state that corporation is incorporated in, there are states that don't let you debit Treasury states.
• 31:28
  SPEAKER_00: Oh they essentially force you to do what we call constructively retire the shares, which would mean you'd actually debit your PAR and debit your APIC in in a manner that we'll talk about in a in a minute or two.
• 31:41
  SPEAKER_00: So there are states, there's not a lot of them, but there's a few that require you to um constructively retire shares.
• 31:48
  SPEAKER_00: And Delaware is not one of those, by the way.
• 31:50
  SPEAKER_01: So if you're incorporated Delaware, you're safe.
• 31:53
  SPEAKER_01: So assuming you don't have to constructively retire, then what do you do?
• 31:57
  SPEAKER_00: You just um debit treasury stock for the fair value of the shares and and you know we would have credited cash.
• 32:03
  SPEAKER_00: Yeah.
• 32:04
  SPEAKER_01: All right.
• 32:04
  SPEAKER_01: So that's easy enough.
• 32:05
  SPEAKER_01: And then I guess ultimately you could retire those shares, actually retire those shares if you want to.
• 32:11
  SPEAKER_01: But then in this constructive retirement, what does a company need to do?
• 32:16
  SPEAKER_00: So this is where you know it's important that you have good control over um what you've actually placed in equity when you sell shares or deliver shares pursuant to um, you know, um uh compensation contracts and and things like that.
• 32:32
  SPEAKER_00: Um there's two methods that you can use to constructively retire or retire your shares.
• 32:38
  SPEAKER_00: Obviously, we're gonna debit par, assuming there's a par value for the stock, right?
• 32:42
  SPEAKER_00: Um that's a minimal amount.
• 32:44
  SPEAKER_00: Um, secondly, we can either debit the entire amount that we paid in excess of par to retained earnings, or we can allocate the amount that we paid between APIC and retained earnings.
• 33:00
  SPEAKER_00: And the amount of APIC that we can charge for the repurchase of those shares is really based on how much APIC we created.
• 33:08
  SPEAKER_00: Oh, when the shares were when we sold the shares.
• 33:11
  SPEAKER_00: So typically what I've seen is companies keep a running average, you know, I call it the average cost, but it's really the average amount that they put in APIC for all of their share issuances.
• 33:22
  SPEAKER_00: And when they pull it out of APIC, they pull it out at that average amount and keep a running total of those shares.
• 33:29
  SPEAKER_01: Aaron Powell Yeah, because that seems advantageous for us as reducing the entire amount against retained earnings.
• 33:35
  SPEAKER_01: Just I mean, sometimes you can run into trouble, right, if you're if you don't have a lot of retained earnings.
• 33:41
  SPEAKER_00: So well, and also if you think about it, you know, when companies have ongoing share repurchase programs, assuming their stock price is increasing over time, they're definitely pulling it out at more than they sold it for.
• 33:52
  SPEAKER_00: Yeah.
• 33:53
  SPEAKER_00: Right.
• 33:53
  SPEAKER_00: Um, on average over time, right?
• 33:56
  SPEAKER_00: So yeah, you know, you could you know end up with accumulated deficit, and we see that.
• 34:00
  SPEAKER_01: Yeah, yeah, yeah.
• 34:01
  SPEAKER_01: So definitely something to be very cautious about.
• 34:03
  SPEAKER_01: All right.
• 34:04
  SPEAKER_01: Well, a lot to think about here.
• 34:06
  SPEAKER_01: Again, to your point, this is something we're seeing more.
• 34:08
  SPEAKER_01: So it's important for people to make sure they're paying attention to the guidance.
• 34:12
  SPEAKER_01: So two final questions for you.
• 34:14
  SPEAKER_01: So, first one is just dealing with these types of transactions.
• 34:18
  SPEAKER_01: You know, I always have to ask, what's your words to wisdom?
• 34:21
  SPEAKER_00: Well, there well, there's one more thing I do want to mention.
• 34:23
  SPEAKER_01: Oh, okay.
• 34:23
  SPEAKER_00: And that is if we run into a situation where our retained earnings, you know, if if by repurchasing shares we would put our retained earnings, oh, that you actually do go negative earnings.
• 34:34
  SPEAKER_00: You know, so what what we say is um there's a sab topic, it's called sab topic 3C.
• 34:40
  SPEAKER_00: And that sab topic deals with deemed dividends on preferred stock.
• 34:45
  SPEAKER_00: But basically what it says is when you have a deemed dividend on your preferred stock, you would debit retained earnings until retained earnings is zero.
• 34:53
  SPEAKER_00: And then when retained earnings is zero, you would debit APIC.
• 34:56
  SPEAKER_00: And then when APIC is zero, you would debit accumulated deficit.
• 35:00
  SPEAKER_00: And so we think a reasonable way of dealing with this is when that would happen by through a share repurchase analogized to that SAB topic.
• 35:09
  SPEAKER_00: And so in that case, we would debit the excess over par and APIC, assuming you're in the allocation method, we go to retained earnings till retained earnings was zero.
• 35:18
  SPEAKER_00: Then we would debit APIC to the extent there's APIC of that same class of shares, and then any excess over that we would put to accumulated deficit.
• 35:28
  SPEAKER_01: All right.
• 35:28
  SPEAKER_01: So lots to think about.
• 35:31
  SPEAKER_01: Yeah.
• 35:32
  SPEAKER_01: Well, it's also interesting to think if a company is going to flip into an accumulated deficit by repurchasing shares.
• 35:39
  SPEAKER_01: It's just an interesting convergence of events that you would have that.
• 35:43
  SPEAKER_01: Right.
• 35:44
  SPEAKER_01: Yeah.
• 35:44
  SPEAKER_01: All right.
• 35:44
  SPEAKER_01: Well, so John, as always, very nice to talk to you.
• 35:48
  SPEAKER_01: This is relatively more straightforward than some of the other topics I know we're talking about this month, but nonetheless, still quite complicated.
• 35:55
  SPEAKER_01: So, what are the words of wisdom that you would have for our listeners?
• 35:59
  SPEAKER_00: You know, it's the I I think I already mentioned it in this podcast.
• 36:02
  SPEAKER_00: I I think it's important, particularly on the more complex derivative-related trades, um, to make sure, you know, you you have all the contracts, make sure you read the contracts very, very carefully.
• 36:14
  SPEAKER_00: And it's always good to have some experienced eyes look at it.
• 36:17
  SPEAKER_00: That's my advice.
• 36:18
  SPEAKER_01: And in this case, for our listeners, if you'd like to read about it before you talk to some experienced eyes, you can look in chapter nine of the financing guide.
• 36:27
  SPEAKER_01: So, John, as always, such a pleasure to talk to you, and thanks so much for joining me today.
• 36:31
  SPEAKER_00: Thanks, Heather.
• 36:33
  SPEAKER_01: That's our show for today.
• 36:36
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• 36:41
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• 36:46
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• 36:56
  SPEAKER_01: From Thought Leadership at PWC, I'm Heather Horn.
• 37:00
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