Last December, I about different ways to offer stock to the public and the role played by the underwriter. (link) Reading about a new deal announced on Tuesday by Aurora Cannabis to sell its stake in publicly-traded Alcanna Inc. (link), I thought it might make sense to revisit that article, since this deal provides a twist on underwritten offerings.
According to the press release, Aurora has hired a syndicate (unaffiliated group) of underwriters to purchase Aurora’s common stock holdings in Alcanna on a “bought deal” basis, and then sell them to the public at a specific price. This is known as a secondary trade, since these are already-issued shares, as opposed to a primary offering of newly-issued shares (such as an IPO). Unpacking some of what that means:
- What is an underwriter? This is an investment bank or other firm that acts between an issuer/seller and investors (here, the public) to sell securities (or other financial products).
- What is a “bought deal”? Quoting myself, a bought deal is an offering of stock where the underwriter agrees to purchase the stock before then selling (or, actually, reselling) that stock to investors. Since the underwriter now has the risk of not being able to resell the stock that it now owns, typically it will purchase the stock at a greater discount to market (or, here, the price being offered to the public) in order to compensate for that risk.
- Who sets the sale price to the public? This is typically negotiated between the seller and the underwriter, to try to find a balance between maximizing proceeds to the seller and making the price attractive enough to find buyers for all of the stock (since the underwriter typically does not want to hold onto the stock).
- Why pay an underwriter to do this? Well, it’s not necessary to use an underwriter to sell. As usual, I am grossly oversimplifying this, but a seller who owns freely-resaleable (tradeable) shares of stock of a public company could just open an online brokerage account and place a lot of trades. Imagine though how long it would take to sell off a 23% stake in another company, particularly without affecting the stock price - securities laws generally require public disclosure of sales by larger holders (such as on a Schedule 13D/G or Form 4 in the US), so the public will know that a big owner is selling, potentially affecting the share price (although, at the same time, the public may like the fact that more shares are hitting the market, reducing an “overhang” of a single holder retaining a very large position).
Using an underwriter, particular on a bought deal basis, gives the seller certainty that it will be able to liquidate its position at a known price, while the underwriter is better positioned to market the shares to institutional investors in a manner that (ideally) minimizes the effect on the market price.
- Why not just use a broker to place a couple of big trades to sell the stock? This is known as a “block trade”. Depending on securities laws and exchange rules, a seller may be able to use a broker to find a buyer for these shares. Typically, the fees would be lower, since the broker is not taking any execution risk compared to the underwriter. However, similar to trickling out the shares in a lot of small trades, when a series of large trades get quoted (either by the large trade “hitting the tape” at the sales price or through required filings (see above)), the seller runs into the same problem of potentially driving down the stock price because a large holder is selling. The block trade is most effective when the sale can be done in one batch, particularly all executed at the same time – something you can’t effectively do with a 23% block.
- Why not just ask around to find a buyer for the shares? Related to the “block trade”, a seller might be able to find their own buyer for the shares and negotiate a sale, avoiding broker and underwriter fees (but certainly paying their lawyers to document the sale). This also depends on securities laws, and is also an option, but it can be hard to find a buyer for a 23% stake in a public company.
A seller hires an investment bank for, among other things, their relationships – in this case, with institutional investors (mutual funds, hedge funds, pension funds) who would love an opportunity to buy a large chunk of shares without having to build up a position in open-market trades (risking pushing up the price). Also, there could be a change of control issue with a single buyer acquiring 23%, particularly without the issuer knowing it (the issuer’s contracts could be affected, and there could be securities law and takeover statute implications).
As usual, none of this is legal advice and I’m particularly not a Canadian securities lawyer (Aurora and Alcanna are both Canadian). This deal helps illustrate not just the complexity of exiting a position (or, as non-traders call it, “selling”), but also that there are a lot of considerations in choosing the best way to do it.