To Sell or Not to Sell - Mini-Tenders are the Question

by Kathleen P. Chimicles, ASA

In the morning mail I notice a one page letter from a company I do not recognize. The letter is an offer to purchase units in a partnership I bought 10 years ago. The letter does not tell me anything other than the name of the company who is offering to buy and the price. Is this a serious offer? Is the offer legal? How do I decide what to do? Where do I go for more information? What alternative do I have?

This mysterious letter is a classic unregistered tender offer, often referred to as a mini-tender.

What not to do when you receive a Tender Offer

What to do before you accept a Tender Offer

Rule of Thumb for Unregistered Tender Offers

In general, a mini-tender is not a good deal unless you have to sell or are anxious to sell immediately. Not always, but often, the proceeds from the secondary market will be greater than the proceeds from the tender offer.

A Primer on Registered and Unregistered Tender Offers

Almost daily, the financial press features one or more transactions between public companies, which are combining operations. Sometimes the combination is accomplished by one company buying the other where the acquiring company offers to purchase the shares of the target company. This offer is made by a tender offer to the shareholders. Many times, the offer price is greater than the stock price before the offer. For public companies, market forces including other bidders and pressure from investors work to force a buyer to pay a fair price.

However, for companies with only a small amount of stock outstanding and/or little analyst coverage and, in particular, for partnerships, the absence of market forces creates the opportunity for buyers to offer low prices and for uninformed sellers to accept such unfair and inadequate offers. Many times these unfair offers are made through the use of an unregistered tender offer.

Under the rules of the Securities and Exchange Commission (SEC), if a person or company wishes to buy more than 5% of the outstanding units of a partnership (or shares of a public company), a formal registered tender offer must be made. A registered tender offer must be made through the distribution of a Schedule 14-A Information - a document which provides a significant amount of information to the sellers including a description of the buyer, the reason the offer is being made, and how the price compares to other forms of liquidity such as recent trading prices. While a 14-A is a lot of reading, it is intended to be informative so that a seller can make an informed choice whether to sell or whether not to sell.

If an offer is made to purchase less than 5% of the shares or units, a 14-A is not required. In fact, there are no regulations concerning the type of information to be provided in an unregistered tender offer.

In partnerships, mini-tenders are typically made for a number of units up to 4.9% of the units outstanding. This limitation is established to avoid implicating a provision in many partnership agreements that the provides the ability of the general partner to deny the transfer of units in excess of 5% of the units outstanding in any one year.

Unregistered tender offers are legal. They are popular in limited partnerships because the limited partnership investments are highly illiquid - there exists a limited market to buy and sell units, most limited partnerships have been around a long time and many limited partners are anxious to be rid of them, and all information regarding the future of the partnership assets is in the hands of the general partner.

Caution, the entities that have been active in making mini-tenders for partnership units are now using the technique to offer to buy a small number of shares of stock of publicly traded companies at prices which are far less than the market price, even after adjusting for broker's commissions.

Who makes an unregistered tender offer and why?

Third parties and sometimes the general partner will make a mini-tender offer. Either entity likely has more information about the current and future prospects of the partnership than do the limited partners.

The principal motivation of any buyer is to purchase something at as low a price as possible. The objective of any seller is to receive as much money for the item sold as possible. Somewhere in the middle is a fair value. In a tender offer, the buyer wants to purchase the units for an amount that is less than the cash the buyer expects to receive from future cash distributions and a liquidating distribution. A limited partner who wants to sell the unit today is willing to accept a price lower than the sum of the expected future cash flow because the money can be spent today or invested in another investment such a mutual fund.

Sometimes, the tender offer price is a reasonable offer. Many times the price offered is very low compared to what the limited partner could receive if other liquidity options were considered or if the limited partner continued to hold on to the units. Sometimes, the offer is outrageously low. As an example, an offer was made to buy units of a certain partnership at $40 per unit when the partnership was in the process of liquidating and would distribute $80 per unit within days of the offer closing.

How much the offer price is less than the expected future cash payments depends on the return the buyer wants to receive. If a unit is bought for $40 and a $50 liquidating distribution is paid a year later, the buyer earns a 25% return in one year ($50 received from liquidation minus $40 paid to buy the unit equals a $10 profit. A $10 profit divided by the $40 price to buy the unit equals a 25% return). The higher the expected return, the lower the price offered to buy the unit. The buyer who paid $40 for a unit and received an $80 liquidating distribution a month later earned a 100% return in one month.

Many times mini-tenders are made to take advantage of the lack of information known by the limited partners or to exploit the situation where limited partners do not pay close attention to these investments and are not aware of alternative liquidity opportunities.

How to evaluate a tender offer.

In a nutshell, the initial steps to evaluate a tender offer are: (1) read the Schedule 14-A Consent Solicitation and Proxy, if provided, (2) read the most recent investor communication from the general partner, (3) read the most recent annual report and Form 10K filed by the partnership with the SEC, (4) research the secondary market activity for the units, (6) read industry newsletters, and (7) call the general partner and ask questions.

1. The 14-A will be part of the package received in a registered tender offer. Investor communications, usually in the form of a letter or pamphlet are provided from the general partner quarterly.

2. Each quarter, the general partner must file a Form 10Q and once a year a Form 10K with the SEC. These documents contain more information about the operations of the partnership than is provided in the investor communications. You can request a copy of these documents from the general partner but it may take a while for you to receive them. Copies of Forms 10Q, 10K, and other filings can be ordered directly from the SEC through a document service. The cost is approximately $20 to $35 per document, but you will receive the documents within a few days. Document services include: Docutronics 800-227-5595 and Disclosure 800-638-8241. Such documents for some partnerships may be available through the SEC website, Edgar on the Internet. Visit http:www.sec.gov./edgarhp.htm.

3. An informal system exists which brings together buyers and sellers of limited partnership units. This system is generally referred to as the secondary market. About 15 companies serve as intermediaries to arrange transactions. Prices on the secondary market may be higher or lower than the price of a tender offer. One difference, in the secondary market, transaction fees have to be paid which reduces the cash you put in your pocket from the sale. In a tender offer, the price that is offered is the amount of cash you receive. For more information about the secondary market, including prices and transaction costs, you can call American Partnership Board 800-736-9797 extension 2 or visit the website: www.APBOARD.com.

4. In addition to this newsletter, Partnership Spectrum is a newsletter that reports on trends and gossip in the partnership sector. Published bi-monthly, Partnership Spectrum discusses trends, general partners, certain tender offers, and includes historical prices for partnerships from the secondary market, and recent net asset values. The annual cost is $115. Call 800-634-4614 for more information.

5. Certain firms provide valuations of limited partnerships. These reports are not inexpensive, a few hundred dollars, but the information is gathered an analyzed by a third party, not the general partner. Be sure to inquire as to any associations between the valuation firm and the general partner. The firms include: Securities Pricing & Research 800-895-4100 and Valuations Group 800-824-5500 and can be reached by links through the American Partnership Board website.

6. The general partner is obligated under the terms of most partnership agreements and state partnership law, to provide the limited partners access to the books and records of the partnership. When you call the general partner ask whether the general partner has taken a position with respect to the tender offer and the reasons for its position (see below). Has the partnership considered liquidation, if so what is the timing and the expected proceeds? What are the future expectations for the partnership? Has the general partner prepared a net asset value? If so, what are the assumptions? You should be permitted to look at the books and records of the partnership in the offices of the general partner upon request.

Items two through five above will only be available for public limited partnerships. If your partnership is a private partnership, the only source of information is the general partner.

When reviewing the research materials, be sure to note any references to a net asset value (NAV) or a liquidation value either for the partnership assets as a whole or individually. The NAV is typically an estimate made by the general partner of the value of the assets less the liabilities. Whether a NAV reflects a conservative or aggressive estimate of value is in part determined by the motivation of the general partner (see General Partner Motivations, below).

Once you have collected information, you need to determine if the price you have been offered is acceptable to you. If you are willing to sell at any price just to avoid receiving another K-1 for your tax return, then only a little research is necessary. First research the likely liquidation date and proceeds. If liquidation is expected within a year and the liquidation distribution is fairly certain, then selling now is most likely not the best course. If the liquidation is too far in the future or the proceeds too uncertain, and you do not want to take the chance of waiting, then a simple comparison need be done. Compare the cash you will receive from the tender offer to the cash you would receive after transaction costs in the secondary market and take the highest offer.

If you have decided that you might sell if the price is right but that you would also be willing to wait until the partnership liquidates, then you need to do more homework. Find out as much as you can about the current operations and future cash flow expected from the partnership. Investigate the liquidation prospects for the partnership assets and the estimated value of the assets if they were sold today. Find out as much as you can about the entity making the offer. This research will help you estimate how much of a discount to the future cash flow the offer represents. Then you have to determine how much of a lower price today are you willing to accept to avoid the risk that in the future the cash you expected will not be paid or will be lower than you expected. Keep in mind, however, the cash could be higher than you expected.

An informed limited partner who asks the right questions and conducts some research should be able to evaluate the merits of any tender offer received, registered or unregistered (even a registered offer can be for an unfair or inadequate price). Sometimes the answer will be to sell; other times to hold, and sometimes the answer will be to sue.

Adjustments to the price offered

Caution, whenever you evaluate the price someone has offered for a partnership unit, be sure to understand how distributions are treated in the offer.

1. Some offers are structured so that all distributions are paid to the buyer after the time you agree to sell even if you have not yet received payment for your units. The worst example of this I have seen is where an offer was made to buy up to 10% of the units over time. Sellers were required to submit the units to be sold to the buyer who would make payment to the seller only when the general partner transferred ownership to the buyer. Since most partnerships limited transfers to less than 5% a year, the seller could wait for 2 years or more to receive payment, yet the buyer was getting all the distributions during the two year period. Run from this type of tender offer.

2. A common structure results from the time lag between when a buyer and a seller reach an agreement and when the general partner changes the ownership records. Since the ownership records determine who receives the quarterly distributions, sellers may receive distributions even after they have sold units to someone else and have received payment for the sold units. In this situation, the purchase price is reduced by the distributions that will be paid to the seller after the seller receives payment for the sold units from the buyer. Sometimes this structure is fair, sometimes not. Be sure to understand exactly what the seller is paying for and what you are giving up.

Motivations of the General Partner

The general partner may the entity making the offer, or may oppose the offer, or may support the offer. Whatever the position of the general partner, its recommendation should be taken with a healthy dose of skepticism. Remember, in a partnership, the general partner always knows more than any other entity about the value of the assets and the future prospects for the partnership. Further, while there are general partners that strive to fulfill their duties and deal fairly on behalf of the limited partners, most partnership operations involve some degree of conflict of interest with the general partner. From conflict flows the potential for abuse at its worst and transactions that are not in the best interest of the limited partners at its most frequent.

1. If the general partner has made the tender offer, it is interested in maximizing its return and the price is certainly on the low end of fair, at best. One exception, is when the offer is made as part of a settlement of litigation. Ours firms have structured settlements that required the general partner or the partnership to buy units to create some short-term liquidity for the limited partners. Offers related to litigation settlements are typically priced above the secondary market and often at or near the net asset value. These offers should be considered seriously. Include in your research of offers related to settlements, a review of the notice of settlement that will describe how the price was determined and how the price compares to other liquidity options.

2. If the general partner opposes the tender offer, it may be because the offer is highly unfair and the general partner's recommendation is sound. Or it may be because the general partner does not want to lose its position as manger of the assets and the prospect for future fees. The plans for liquidation and the expected liquidation proceeds are important inputs to evaluate the soundness of the general partner's position in this situation. Call the general partner and ask why it recommends against the tender.

3. If the general partner supports the tender offer, it may be because the general partner stands to profit from the tender, probably indirectly. Look for prior or pending transactions in which the general partner and the buyer are involved. Pay attention to individual names, not just entity names. Often the same people are involved with several entities of different names.

4. If the general partner is silent as to the tender, it could be because the general partner is not paying attention. Or because the general partner has a relationship with the buyer. Or because the offer is not terrible, worth considering by all limited partners, and worth accepting by some.

If you sell, be sure to follow-up on the transaction

Sometimes, the paperwork does not get prepared properly or in a timely manner; sometimes, it falls through the cracks. Be sure you know when you will receive payment for your units before you forward the transfer papers. Be sure you receive your payment when you expected. If you do not receive your payment, complain to the buyer and to the general partner. The general partner is responsible for maintaining the records of ownership. If you have not received payment from the buyer, the general partner should not transfer ownership of the units to the buyer. If you have sold your units, have not received payment, and a normal quarterly distribution has been paid that was not paid to you, call the general partner immediately. We have seen situations were the ownership transfer was made on the books of the partnership so that all distributions were paid to the buyer, but the buyer never paid the seller for the units.

Be sure to inform your accountant and financial advisor of the sale so that your taxes and your portfolio records are correct.

When to consider suing the partnership or the general partner

Sometimes the unfairness of a transaction or the actions of the general partner are highly self interested that bringing a lawsuit is the only way to protect your interests or to bring about change. It is worth exploring your rights with an attorney when faced with the following situations:

1. The general partner has made a tender offer for limited partnership units.

2. The general partner proposes to sell some or all of the assets of the partnership to itself or to an entity associated with the general partner or to the individuals who own or operate the general partner.

3. If the general partner purchases assets for the partnership from itself or a person or entity that is affiliated with the general partner.

4. The general partner proposes to combine the assets of the partnership with the assets of one or several other partnerships and create a new entity such as a REIT.

5. The general partner refuses to answer your questions and/or provide you access to the books and records of the partnership.

6. The general partner proposes to sell its general partner interest to another person or entity.

7. The partnership is beyond the time when it was to be liquidated either according to the terms of the partnership agreement or the statements made in the prospectus and the general partner has made no efforts to commence liquidation.

8. The general partner proposes changes to the terms of the partnership agreement.

9. For partnerships organized within the last few years, the first time the operations of the partnership do not meet the expectations promised to you when you bought the investment.

Reprinted from the Partnership & Reit Litigation Newsletter, Winter/Spring Issue, 1999.