The realities of linguistic sciences and the financial world do not appear to be very close. Semantics is the part of the linguistic sciences that studies the meaning of words and expressions when we are speaking or writing. A share buyback is the operation by which a company buys its own shares on the market, usually with the idea of amortizing them.
Recent statements by the chairman of the Comisión Nacional del Mercado de Valores (CNMV), the Spanish markets regulator, have brought these different worlds together, however. He asked, for semantic reasons, whether share buybacks should not be identified with remuneration for all shareholders. These comments came just 10 days after the new CEO of Santander, one of Europe’s largest banks by market capitalization, announced its new share buyback and redemption program as an instrument of shareholder remuneration.
The idea that share buybacks are a form of shareholder remuneration is yet another example of the psychological importance of repetition. Repeating a word, concept or idea makes it commonly accepted. This phenomenon is very common in political debate, as political pollster and strategist Dr Frank Luntz explains in his book Words that work.
In repurchase transactions, a shareholder sells shares in the market and these are acquired by the company. By selling the shares the investor ceases to be a shareholder. Shareholders that do not sell receive nothing and so are not liable for tax on the transaction.
It seems the Treasury agrees with the chairman of the CNMV that share buybacks are not a concept that can be equated with shareholder remuneration. If we go back to semantics, retribution – from the Latin ‘retributio’ – means reward or payment.
Comparing apples with oranges
Probably the confusion comes from not differentiating between the total value of the company and the price per share. For the same market value of the company, for the same profit or the same cash flow, dividing it by a smaller number of shares means the profit per share increases.
But this ‘mathematical’ increase does not automatically translate into the market price per share. The intrinsic value of the company, which is derived from the future performance of its business, does not change by amortizing shares. In fact, the total value of companies that buy back and redeem shares decreases compared with the previous situation.
The reason is that we need to subtract all the cash spent on that share buyback from the previous value of the company (or subtract the increase in debt to finance the buyback). With current interest rates at 4 percent, the financial cost of the multi-billion-dollar buyback programs is also significant, despite the tax savings associated with such expenditure, diminishing company earnings.
Alongside the semantic reasons, the CNMV chairman spoke of historical reasons. The data suggests that share buybacks do not translate into a sustained and significant increase in company share prices. Philosopher George Santayana’s famous quote holds true: ‘People who do not know their history are condemned to repeat it.’ Repeated buyback programs by European telecommunications companies and banks have not slowed the decline of their share prices over the last 15 years. When business fundamentals fail, share buybacks are just a few drops in the immensity of the ocean sweeping over share prices.
Adding to the debate on this issue has been the idea that buying shares below book value, which is the case for bank shares, makes sense for shareholders. The problem is that book value is an accounting concept that reflects accumulated historical results, except in some cases of asset revaluation. Investors do not buy the past, they only buy the future of business growth and profits.
Share buybacks make sense when the business is believed to have a theoretical fundamental value well above the share price. It is true that by reducing the number of shares, shareholders increase their percentage stake in the company’s capital. This relative increase entitles them to receive a larger share of the potential higher future flows.
The problem with this ‘futuristic’ and far from tangible benefit is that investors very often do not believe certain companies or sectors will increase their future flows. In many cases they do not even believe that some sectors can maintain their current flows. Therefore, they do not believe in that theoretical fundamental value. Stocks of companies with poor prospects tend to return to their previous levels or continue to decline after buyback programs are completed.
Following the scrip
Companies insist on devoting resources to buybacks but, often, the market does not recognize the potential greater future value via share appreciation in the present. In this case, shareholders would be better served if the cash spent on such buybacks were distributed annually via a special cash dividend.
In terms of semantics, it is striking that after the 2008 global financial crisis, the so-called ‘scrip dividend’ became popular as a form of shareholder remuneration. This formula is basically a capital increase via the issuance of new shares. Shareholders could choose to sell their subscription rights for an amount equivalent to the cash dividend, or receive new shares. With this form of remuneration, the tax authorities tax the profit obtained at the time of the sale of the rights or of the new shares.
This form of remuneration was widely used by European banks. By issuing capital and not repurchasing the shares, they avoided the cash payment of dividends, which allowed them to restore their damaged balance sheets. In this case there is dilution of shareholdings, so it isn’t remuneration. If the company issues new shares and then repurchases and redeems the issued shares to keep its final number constant, that’s shareholder remuneration. The amount paid out by the company would be equivalent to having paid the traditional cash dividend.
A scrip dividend involves increasing the company’s capital out of reserves. A share redemption is a reduction of capital. It does not seem that diametrically opposed transactions can both be identified as ‘shareholder remuneration’.
Ricardo Jiménez is an IR strategic adviser and commentator and the former award-winning director of IR at Ferrovial from its IPO in 1999 until 2020