When I first encountered the term issue by tender, I found it shrouded in financial jargon. Over time, I realized it’s a critical method companies use to raise capital, yet many investors and finance students struggle to grasp its mechanics. In this guide, I break down the concept, explain its advantages and drawbacks, and provide real-world examples to help you understand how it works.
Table of Contents
What Is an Issue by Tender?
An issue by tender is a securities offering where investors bid for shares within a specified price range. Unlike fixed-price offerings, this method allows the market to determine the final issue price. The company sets a minimum price (the reserve price), and investors submit bids at or above this price. The highest bids are accepted until all shares are allocated.
Key Features of an Issue by Tender
- Price Discovery Mechanism: The market sets the price based on investor demand.
- Reserve Price: The minimum acceptable bid price set by the issuer.
- Competitive Bidding: Investors compete, ensuring fair pricing.
- Partial Allotments: Large bids may receive only a portion of requested shares.
How Does It Work?
Let’s walk through the process step by step.
Step 1: Setting the Reserve Price
The issuing company, with the help of underwriters, determines a reserve price. This is the lowest acceptable bid. For example, if a company wants to raise \$50 \text{ million} by issuing 5 million shares, the reserve price might be set at \$10 per share.
Step 2: Inviting Bids
Investors submit bids indicating how many shares they want and at what price. Suppose three investors bid as follows:
| Investor | Bid Price (\$) | Quantity Requested |
|---|---|---|
| A | 12 | 2,000,000 |
| B | 11 | 1,500,000 |
| C | 10 | 1,500,000 |
Step 3: Determining the Strike Price
The strike price is the lowest accepted bid that allows full subscription. Here, if the company accepts bids from A and B, it raises:
(2,000,000 \times 12) + (1,500,000 \times 11) = \$24 \text{ million} + \$16.5 \text{ million} = \$40.5 \text{ million}But it needs \$50 \text{ million}. So, it must also accept C’s bid at \$10, raising an additional \$15 \text{ million}. The strike price becomes \$10.
Step 4: Allocating Shares
Since demand exceeds supply, shares are allocated starting from the highest bids. Investor A gets all 2 million shares, B gets 1.5 million, and C gets only 1 million (since only 4.5 million shares remain).
Advantages of Issue by Tender
- Fair Pricing: The market determines the price, reducing underpricing risks.
- Investor Participation: Encourages competitive bidding, ensuring liquidity.
- Flexibility: Companies can adjust the reserve price based on market conditions.
Disadvantages of Issue by Tender
- Complexity: Requires precise valuation and investor coordination.
- Potential for Low Bids: If demand is weak, the strike price may be near the reserve price.
- Partial Allotments: Large investors may not receive full requested quantities.
Real-World Example: The UK Government’s Bond Tenders
The UK Debt Management Office (DMO) frequently uses tenders for gilt issuances. In 2022, it issued \$3 \text{ billion} in bonds via tender, with bids ranging from 1.2\% to 1.8\% yield. The strike price settled at 1.5\%, balancing demand and supply.
Mathematical Modeling of Issue by Tender
To understand pricing dynamics, we can model the expected strike price (P_s) as:
P_s = \frac{\sum_{i=1}^{n} (Q_i \times P_i)}{Q_{\text{total}}}Where:
- Q_i = Quantity demanded at price P_i
- Q_{\text{total}} = Total shares offered
Example Calculation
Suppose a company offers 1 million shares, and bids are:
| Bidder | Price (\$) | Quantity |
|---|---|---|
| X | 15 | 400,000 |
| Y | 14 | 300,000 |
| Z | 13 | 500,000 |
The strike price becomes:
P_s = \frac{(400,000 \times 15) + (300,000 \times 14) + (300,000 \times 13)}{1,000,000} = \$14.1The remaining 200,000 shares from Z are rejected.
Comparing Issue by Tender vs. Book Building
| Feature | Issue by Tender | Book Building |
|---|---|---|
| Price Determination | Market-driven bids | Underwriter negotiation |
| Flexibility | High | Moderate |
| Complexity | High | Medium |
| Investor Control | Direct | Indirect |
Regulatory Considerations in the US
The SEC governs securities offerings under the Securities Act of 1933. Key rules include:
- Regulation D: Exempts private placements from registration.
- Rule 144A: Allows resale to qualified institutional buyers.
- Shelf Registration (Rule 415): Permits phased offerings.
Final Thoughts
Issue by tender is a powerful yet underutilized method in the US, where book building dominates. By letting the market set prices, it minimizes mispricing risks and democratizes access. However, its complexity deters smaller firms. For investors, understanding this mechanism can uncover lucrative opportunities in primary markets.
