What Is A Block Trade?
For a company that is already publicly listed, there are times when an investment bank or a syndicate of investment banks will purchase a significant amount of shares from a major shareholder or group of shareholders in a private, negotiated transaction in what is known as a block trade.
If the investment bank(s) are brokering a deal between two major parties, and takes a small commission – underwriting risk is relatively limited.
Most of the time, however, the selling shareholder(s) want to offload their shares quickly and will sell at a discount to current market price to the investment bank for them to offload (a bought or underwritten deal). Banks can also do agency deals where the market risk remains with the selling shareholder – in this case no discount.
Here are some general rules:
- The larger the size of the offering the greater the discount
- The more liquid the stock, the smaller the discount
- The larger the percentage of the shares outstanding, the greater the discount
- The more volatile the markets, the larger the discount
- If the block is sufficiently big, the deal will need to be syndicated across multiple investment banks
Rationale for Block Trades
This ends up benefiting both the seller and the investment bank – depending on how substantial their ownership is in a company, there may not be enough liquidity in the secondary markets to absorb so much selling pressure at once, possibly causing the stock to move down substantially. The discount may well be less than the price they would receive dumping the stock.
The selling shareholder could also consider selling their position over time, but are accordingly exposed to market swings. The block sale immediately passes on equity market risk to the investment bank.
The investment bank profits from the work and underwriting fee as well as the profits they may take from distributing the shares at a higher price than the discounted price they received, as banks often have the best market intelligence. However, this is not to say that banks do not misjudge their ability to sell and take a hit.
Selling stock back to the company in question for cancellation is also an attractive option if the company has spare capital. Mechanically, this is the same as a share buyback, which helps with EPS accretion. This helps the buying company repurchase shares at a cheaper price than purchasing on the open market (which drives the share price up), while the seller can get a lower discount than shopping it out to market via an intermediary (the investment bank). The investment bank may still charge a work fee for the arrangement.
The Seller in the Block Trade
Parties that may engage in a block trade with an investment bank include large shareholders such as pension funds exiting a relationship investment, asset managers that feel that their price target or price floor has been reached, founders or influential shareholders looking to exit or sell down their holdings, and other corporates that own another company’s stock via vendor take-back equity (as part of an asset acquisition, a company offered some of its own stock as consideration) or strategic investments.
Pitching the Block Trade Mandate
Generally, the main relationship bank or the bank that successfully pitched the block trade will lead the transaction. In some markets with oligopolistic investment bank markets, the shares will be syndicated out fairly evenly to other lenders in the selling shareholder’s relationship group to share the economics (fees). In markets with megabanks that have huge balance sheets (the USA), there is often a major bookrunner (lead) for the trade that will take on the majority of the sale.
Timing for Block Trades and Investment Bank Advisory
Investment banks will advise on when a good time to sell is. No one can predict the market, but investment banks generally advise sales if the seller is not under duress when markets exhibit some or all of the following characteristics:
- Robust equity market – Rising markets mean that there will be better liquidity for the stock to be absorbed by buyers
- Low volatility
- High multiples – The seller is getting a historically good price
- Investor appetite for industry – If the market has shown strong demand for tech stocks recently and the seller holds a large block of technology stocks, they can realize a good price
- Quality of underlying company – If the company held is a good operator and has been outperforming expectations, it may be worthwhile to keep holding (for corporates holding other corporates this is especially important – if the underlying company’s return on capital exceeds that of the selling company, it may not be a bad idea to keep it on the books)
- Momentum and direction – Investment banks can run regressions to see if underlying drivers are correlated and where the stock may go later