Is there such a thing as a free lunch?

"SIGN UP HERE FOR A FREE LUNCH!"

I just saw something that sounded even better!

"CAPITALIZING ON UNDERVALUATION – ENABLING A CORPORATION TO SELL A $10 STOCK FOR $30 AS SOON AS IT HITS A $16 TARGET"

I recently came across this claim in a deal structure being promoted by MG Holdings/SIP a corporate finance advisory group. To me it just sounds too good to be true:basically free money for any public company that believes its stock will increase in future price which seems to fit most corporate objectives looking ahead. I checked out their claims on their web site at http:// MGHoldingsSIP.com and cant find the catch! I am sure that there are a lot of really smart CFO / treasurer types out there in proformative-land so I thought I would ask you to check it out and let me have your thoughts and opinions. If its true then it will be the best five minutes you have spent in a long time, and if not, then you will save me a head ache and egg on my face. The following quote is taken directly from their web site! Thanks for your collective help!

Simon

"Undervaluation is an opportunity, not a problem. Depending upon volatility and equity capital costs, a Cashless Buyback^tm exchange offer can allow a company trading at $10 per share to sell stock at $30 per share as soon as its stock rises to a $16 target anytime within 3 years (or, upon hitting the target, the company can instead repurchase 20% of its outstanding shares at a cost of $0, i.e. zero). Importantly, if the target is missed, the firm and its participating shareholders suffer no penalty - no debt, no interest, no cash outflow, no dilution. Tax and accounting are straightforward."

Reference URL: http://mgholdingssip.com/default.aspx

Answers

Mike Gumport Managing Director • November 16, 2010

Simon:

Thank you for your interest in Cashless Buybacks(tm). I am the founder of MG Holdings/SIP, a corporate finance advisory, and a member of Proformative. We do not provide money management services.

I am very interested in responding to the issues you raise and any questions members of Proformative may have.

Over 50 public corporations have requested presentations on Cashless Buybacks(tm). Presentation requests to us typically arrive from the CFO or Treasurer level. The median size of companies to which we present is roughly $1 billion (equity market capitalization). Interested corporations range in size from under $100 million to well in excess of $10 billion.

After receiving my MBA from Columbia University, I served as an "Institutional Investor" ranked semiconductor equity analyst for many years at major investment banks and then as CFO and/or director of several semiconductor startups. As a consequence of my background, client interest in Cashless Buybacks(tm) is concentrated most heavily among semiconductor and related technology industries. However, a Cashless Buyback(tm) can be profitably applied to a company of any size in any industry. The structure is most readily pertinent to a public corporation but also has applications for private companies, particularly as they look towards an IPO.

I have written over 30 papers on the performance, efficiency, accounting, governance and method of execution of corporate stock repurchase programs. I am ranked among the top 1-2% of the 148,000 authors who contribute to SSRN.com (the Social Sciences Research Network, the preeminent site for posting academic working papers). A lengthy discussion of Cashless Buybacks(tm) is available for free download at http://www.ssrn.com/article=1007484 .

The Cashless Buyback(tm) transaction is a new structure. However, it is related to Performance Rights (PRs), Contingent Value Rights (CVRs) and Conversion Rights (CRs). At least several dozen PR, CVR, and CR issuances have been completed. Many of these transactions have been executed for multibillion dollar corporations.

BOTTOM LINE - Yes, a Cashless Buyback(tm) may sound too good to be true - "A company trading at $10 per share, upon hitting a target of $16 per share, can sell stock at $30 per share; if the target is missed, there is no penalty - no debt obligation, no interest, no cash outflow, no dilution to a firm's participating shareholders". Still, upon inspection, you will find that the transaction delivers exactly what it advertises: A corporation is enabled to capitalize on undervaluation at exceptionally low risk.

In short, a Cashless Buyback(tm) should be viewed as a supplement (or superior alternative) to a cash repurchase of shares. It would make sense for any company in a period of undervaluation and/or considering a stock repurchase program to pause to review the merits of a Cashless Buyback(tm).

Thank you again for your interest.

Regards,

Mike Gumport
Founding Director
MG Holdings/SIP

Simon Westbrook CFO • November 16, 2010

I am flattered to have stirred up a response from the originator of the "Free lunch" but the response is obviously biased in favor of MG's product and I am still looking for independent evaluation and feedback on the "Free lunch". If you read the details on the web site you will see that this is not a cash management scheme as suggested by a previous critic, but a managed equity security with claims to incredible upside. In fact, if the upside didnt sound so good, I would be more inclined to believe the claims! However, as much as I read the description on the web site http://mgholdingssip.com/default.aspx I have still not managed to find the catch.
Once again I am asking members to review this proposal and publish their opinion (preferably reasoned) for us all to see. If its real, we owe it to our management as a way of improving EPS and eliminating risk on stock buybacks, if its a scam we owe it to our group members to provide warning. What do you think? Please vote one way or the other so that any conclusions can be based on a reasonable statistical sample!
Simon

John Jepsen Consultant • November 16, 2010

it is the government's ox that is getting gored. I could not tell enough from the website to know exactly what they are proposing though it sounds like you are selling or giving someone else options and in my experience when you do this you always end up with an outcome you did not want. Try to get some more details on the structure and we'll help you sort it out. Ask them HOW it works, whose ox is getting gored, and would you want to see this written up on the front page of the WSJ above the fold.

The other possibility is that they are basing the economics in their presentation on an erroneous base case, or a DO-Nothing base case, which is not right if you are either thinking of issuing equity or doing a share repurchase (and why you would be thinking of doing both in the same breath is beyond me!)

In the final analysis trust your gut on this one.

Mike Gumport Managing Director • November 22, 2010

John - A Cashless Buyback(tm) does not enjoy any sort of tax benefit, so, no, the "government ox" does not get "gored". While a Cashless Buyback(tm) receives no tax benefit, neither does the structure suffer any sort of tax penalty or onerous accounting treatment.

I understand the proposition, at first blush, sounds too good to be true: How can a company with shares trading at $10.00 apiece put in place a mechanism that, as soon as share prices rise to $16.00, permits the company to issue shares at $30.00? And, how can a company achieve this result (the sale of stock at a substantial premium to the market price) while shouldering minimal risk?

In this short note, let me just say that the first step towards implementing a Cashless Buyback™ is for a corporation to divide its existing outstanding Common shares into Class A Common and Class A1 Common through a low cost tender exchange offer. A long (and somewhat academic) discussion of the Cashless Buyback™ structure is available for free download at http://www.ssrn.com/article=1007484 (“The Cashless Buyback – A Superior Alternative to 10b-18 Cash Buybacks...”). That paper explains exactly how a Cashless Buyback™ works, the benefits to corporations, and the benefits to shareholders. If you are curious, all you need do is read the paper.

A concrete example might most quickly explain the transaction. Let me know if you have a case in mind. In a few, brief pages, I can succinctly sketch out how a Cashless Buyback™ could be implemented and achieve its unusual results for the specific case of interest. As I indicated to Simon Westbrook (who started this discussion), I am happy to provide a short presentation to any Proformative member. I am interested in your feedback.

In any case, thanks again for your interest.

Simon Westbrook CFO • November 23, 2010

I read the report referred to in the Social Science Research Network Journal - all 60 plus pages and I have to say I still dont understand how it works! Having experienced the problems associated with a typical cash buy back program I can appreciate the value of this cashless buyback, IF IT WORKS, but I am sceptical how something this good can be real! As a group, we Proformative members have thousands of members, many of whom are wiser then I am, but so far I have only seen two comments, both of which were gut reactions from members who hadnt read the source, or didnt understand it any better than I did. Surely we have members out there who can see whether this offering is real, or a magic trick and explain how it works. If its a scam, it should be exposed to protect our members. Does anyone else have any thoughts other than the usual too-good-to-be-true gut reactions?

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Is there such a thing as a free lunch?

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