Reverse Dutch Auctions
Welcome to the forty-fifth Pari Passu newsletter.
Today, we are going to have a short lesson on a technical concept that is not frequently mentioned: reverse dutch auctions.
Reverse Dutch Auctions
In a typical Dutch auction, participants bid to buy assets, and the seller gets rid of them at the best possible price that will allow it to sell all its wares. In a reverse Dutch auction, the auctioneer is the purchasing issuer rather than the seller. In the latter, the seller seeks to purchase or repurchase a specific amount of goods or assets at the lowest possible price. Sellers compete by submitting bids indicating the minimum price at which they are willing to sell, and the price typically decreases during the auction. The lowest bid determines the price, allowing the seller to achieve its desired outcome.
Debt Buybacks
In a debt buyback structured as a reverse Dutch auction, the lender invites holders to tender bonds at a price specified by the tendering holders, rather than at a price specified by the issuer, and announces its intention to accept as many bonds as needed to purchase the desired number of securities, beginning with bonds for which the lowest price has been specified. By doing so, the borrower can keep the surplus that would otherwise have to offer bondholders as a whole if it had to apply the highest clearing price to all accepted tenders.
Auction Mechanics
In a reverse Dutch auction, the borrower communicates to an auction manager the number of loans it wants to purchase and the range of discounts to par it is willing to accept. Lenders then notify the auction manager about their willingness to sell loans to the borrower, specifying the amount and the discount to par they are willing to accept. The company collects the offers from lenders and analyses them to determine the lowest price that will enable it to achieve the desired debt reduction goal. The lowest purchase price is calculated, which allows the borrower to buy the full offered amount or a qualifying portion if there are insufficient bids. The main reason why a company would undergo a reverse Dutch auction is to resolve its financial problems. It can allow the company to repurchase and exchange its outstanding debt at a discount, reducing the overall debt burden. Additionally, if a company is facing imminent default or bankruptcy a reverse Dutch auction allows the company to negotiate with creditors to avoid default. A successful reverse Dutch transaction can positively impact the company's reputation and market perception. It signals to investors and stakeholders that the company is taking steps to address financial challenges.
Borrowers Perspective
The reverse Dutch auction facilitates price discovery by allowing the borrower to identify the lowest possible price at which creditors are willing to sell or exchange their claims. This helps the company assess the feasibility of its restructuring plans and potentially achieve debt reduction at a discounted price, taking advantage of the discount to par which each bondholder thinks is fair compensation for its individual preference. Given the discount to par that it is able to capture, the issuer can retain the combined surplus that it would otherwise have to offer to bondholders as a whole if it had to apply the highest clearing price to all accepted tenders. The reverse Dutch auction allows participating lenders to set their own minimum prices, providing them with some flexibility in determining the value they assign to their claims. Tension is generated among lenders as each of them is incentivized to offer their holdings at the lowest acceptable purchase price.