Demystifying the Greenshoe option
A greenshoe option is an over-allotment option that gives an entity offering shares to the public to sell to investors up to 15 per cent more shares than initially planned by the issuer when the demand is higher than expected.
The oversubscription of the bond offered by Family Bank has resulted in the popularisation of a previously little-known term – the greenshoe option.
A greenshoe option is an over-allotment option that gives an entity offering shares to the public to sell to investors up to 15 per cent more shares than initially planned by the issuer when the demand is higher than expected.
The term “greenshoe” came from the Green Shoe Manufacturing Company (now called Stride Rite Corporation), an American company founded in 1919. It was the first company to implement the greenshoe clause into their underwriting agreement.
Tony Watima, a Nairobi based Economist, says that the “Greenshoe option allows companies to intervene in the market to stabilise share prices during the 30-day stabilisation period immediately after listing.”
In the case of Family Bank, the bank was seeking to raise Ksh4 billion with a minimum subscription of Kshs100,000 shillings or equivalent, with a five and a half years’ tenure priced at 13.0 per cent per annum. The cash was meant to facilitate the expansion of the branch network and alternative business channels, investment into ICT software and infrastructure upgrade, business growth, including on-lending activities, strengthening the total capital base and part of regional market entry financing.
The greenshoe option allowed the mid-tier lender to raise more money through the bank’s medium-term note. The bond raised Kshs. 4.42 billion shillings against a target of 3 billion shillings from local fund managers, banks, retail investors, insurance companies and other institutional investors. This marked a subscription of 147.3 per cent that was made possible by a greenshoe option of KSh1 billion.
“We are delighted with the performance of the Family Bank Medium Term Note, which is instrumental in reviving our corporate bond market. We have therefore allowed the Bank to take up from the investors the KSh3 billion that was approved for the first tranche and the extra KSh1 billion offered by the same pool of investors, which is the greenshoe option,” noted Capital Markets Authority Chief Executive Wyckliffe Shamiah.
How the greenshoe option works
A company may raise capital for some of its future developmental plans through an Initial Public Offering (IPO) or corporate bond issuance.
During this stage, the company declares an issue price for its securities and announces a particular quantity of stocks that it will issue (say Ksh3 billion securities with a minimum amount of Ksh100,000 in the case of Family Bank.)
The greenshoe clause in an underwriting agreement is then activated if demand for shares is more enthusiastic than anticipated and the stock is trading in the secondary market above the offering price. Therefore, if demand is weak, and the stock price falls below the offering price, the underwriter may purchase the shares at a lower price in order to stabilize the price.
In some instances, the demand for such security may go uncontrollably up, and as a result, the prices will rise. The company will therefore exercise the greenshoe option in order to meet the excess demand. Some of the companies that have explored the greenshoe option include Facebook, Aramco and Shell.