Share buybacks are on the rise again – but not everyone is a fan
If recent volatility in world stock markets is any indication, investors are having a hard time deciding how much public companies are worth. But there’s one group of buyers that continues to snap up shares through it all: the firms themselves.
Stock buybacks in the S&P 500 rose 41 percent over the last year to $109 bn in the second quarter of 2011, the eighth consecutive quarterly increase. It’s a string of shareholder-friendly purchasing that has more than quadrupled from the low point in the second quarter of 2009, when the markets were mired in the worst of the credit crisis, and
buybacks dipped to $24 bn.
The recent activity has revived grumbling from pundits who say the money would be much better spent on research and development – an argument often heard in the run-up to the 2008 market crash. Back then, buybacks soared to record levels, reaching a high of $172 bn in the third quarter of 2007.
‘Any top executive who says a share buyback is the best way a company can use its money should be fired,’ states William Lazonick, an economist at the University of Massachusetts Lowell and one of the most vocal critics of the practice.
Mounting a defense
But most IROs defend buybacks as an investor-friendly policy that makes sense. Among the reasons given are that it’s a good way of returning cash to shareholders, it improves EPS and it covers the dilution caused by the granting of employee stock options.
Buybacks, IROs argue, also send a message to shareholders that is especially important in uncertain times – such as when the market is volatile and investors turn skittish.
Buybacks are an ‘illustration of the board’s confidence in the future of the company to our shareholders, as well as underscoring our commitment to enhancing shareholder value,’ explains Marcy Brand, investor relations manager for Southwest Airlines, whose board authorized a $500 mn stock repurchase in August, after the company’s share price had fallen 35 percent.
‘It’s a matter of looking at our capital base,’ explains Brand. ‘We have a strong balance sheet and liquidity that is currently more than $4 bn, so it’s a way of managing the dilution by buying shares with the overall goal of enhancing shareholder value.’
Kevin Sellers, vice president of investor relations for Intel, also emphasizes the balance of favorable buying opportunities and the desire to send a message to shareholders. ‘A lot of investors like to see that the company believes in its own vision and the value of the stock exceeds the value of keeping the cash on the balance sheet,’ he points out. In the second quarter, Intel spent $2.74 bn on stock repurchases – more than all other technology companies except IBM and HP.
Sellers points out that the buybacks followed a deliberate process of evaluation of the company’s prospects that involved the board and top management. ‘There’s a lot of things you look at,’ he observes. ‘You look at the state of the market and the strategic opportunities, because obviously investing in our business is our number one priority, second is
dividends and third is buybacks.
‘We can look investors in the eye and say, This is a good decision. We have a good handle on our strategy and where we think it will take us, and in general we would like to try to be more aggressive when things seem to be low, valuation-wise.’
Not buying it
Such explanations have done little to quiet critics, however. Michael Gumport, founder of US research company MG Holdings, a corporate finance advisory firm, conducted an unscientific analysis of 280 companies that did stock buybacks between 2000 and 2009. He claims that nearly two thirds of them ended up losing money.
‘A stock buyback is a wonderful idea if management, after careful analysis, concludes the company’s shares are underpriced, and it communicates that to the market so investors are aware of the rationale behind the buyback,’ Gumport says. ‘Unfortunately, that doesn’t seem to be how most buybacks work. The average buyback has been a money-loser – you would have done better as a company just to have put money in the bank and paid out dividends.’
Gumport adds that, in some cases, the selfish interests of those involved – rather than sound market analysis – are part of what’s driving the trend. The rise of executive compensation option packages in the 1990s is motivating executives to sign off on them because it’s in their own personal interests to do so.
Share buybacks, meanwhile, represent a huge and growing business for the money management departments at brokerage houses, which helps to feed a herd mentality. ‘They tell their corporate clients, This is a service,’ Gumport says. ‘But it’s an extremely high-margin business with minimal risk, so advisers advise them to do it.’
Another reason buybacks often lose money, Gumport argues, is that companies sometimes do them to offset the exercise of stock options. Options get exercised only when the share price goes up, however, which ensures the buybacks occur when the share price is high, rather than when it is low.
Lazonick says a misguided trend toward evaluating executive performance based on stock price rather than actual company performance is also driving the trend. Once one company does buybacks, it forces competitors to follow suit, because executives know they will be judged based on how their stock price performs in relation to their competitors. ‘It’s manipulation of the stock market, and nothing more,’ Lazonick asserts.
Home truths
It’s also undermining the future of US economic competitiveness. Often the companies doing buybacks, Lazonick says, are desperately in need of research and development, creating new jobs or buying equipment. As a sector, technology companies topped the list of the biggest spenders on buybacks in the second quarter, doling out $24 bn – 22 percent of the total – in the period April-June of this year.
HP topped the list, buying back $4.6 bn-worth of shares, while IBM splashed out $4 bn. HP, Lazonick notes, spent four times as much on buybacks as it did on research and development in the second quarter of 2011. ‘HP was an icon in American business and is simply trying to get stock price up rather than investing in new products,’ he says. And IBM, he complains, is exporting jobs overseas and then investing the profits in buybacks that do little to create more jobs at home.
‘There’s nothing wrong with going overseas but there’s something wrong with not using profits to invest at home,’ he says. ‘All buybacks do is play with supply and demand. If the money is spent on innovation, on the other hand, everybody gains: there are bigger incomes, more jobs and more taxes. We are not going to get out of the economic problems we are in via government training – we are going to get out of it by businesses starting to spend money on R&D and new equipment.’
Biggest buyer
ExxonMobil topped all other firms last quarter, repurchasing $5.5 bn-worth of shares. Exxon spokesperson Cynthia Bergman White insists ‘investing wisely in attractive energy opportunities is our first priority’, adding that buybacks and dividends are part of an effort to ‘return cash to our shareholders through buybacks so they can redeploy it in
the economy.’
Over the last five years, the company has bought a total of $114 bn or nearly 19 percent of the shares, more than twice the total of any of its competitors.
‘We are committed to returning excess cash to shareholders while ensuring attractive investment opportunities are fully funded for the future,’ Bergman White says. ‘The share repurchase program also provides value through increasing per-share ownership of ExxonMobil’s underlying assets.’
She further notes that each share of ExxonMobil has an interest in 28 percent more production volumes and 32 percent more reserves today than it did in 2006. ‘We believe the share purchase program is an effective way to distribute value to shareholders while maintaining the flexibility to balance the cash needs of the corporation,’ she concludes.
