I Want My Buybacks Back

TO BE SUCCESSFUL, YOU MUST PORTRAY AN IMAGE of success. One good way to appear successful is by appearing to be popular. The more in demand you seem, the more in demand you’ll be. This is true in many aspects in life and is evident in the stock market as well. If a company doesn’t have many available shares on the open market, it seems like an in demand and sought after investment. Share prices will certainly go up.

Many corporations will do anything to improve their stock price. Instead of going about this the natural way, many are simply buying back their own shares in a way to reduce the supply on the open market. This seems like it would make sense, but the strategy does not always pan out.

One of the worst cases was that of Ambac, which borrowed money to buy back shares right before it collapsed. While the company was buying back its own shares right before the price fell, the CEO and former CEO were able to dump millions of dollars worth of shares just before the collapse.

However, it’s not just a handful of companies involved in poor decisions. TheWall Street Journal reports:

“Driven by billions of dollars in share buybacks, record-setting buyouts. and a wave of mergers, the amount of stock in the market shrank by hundreds of billions of dollars in the past four years.

“With the supply of stock down and demand strong, the market rallied. Now, as the economy slows and credit markets buckle, high-profile companies are cutting back on buybacks, and some wish they held onto the cash they gave back to shareholders…

“Shares of Freddie Mac fell 29% on word that the mortgage company may halve its dividend and seek a capital infusion amid a record loss. Freddie might not be in this position if it hadn’t bought back at least $1 billion of common stock earlier this year and replaced it with preferred shares.

“Fannie Mae, the largest U.S. home-funding company, has tapped the markets more recently, raising $1.5 billion in less than two months by selling preferred stock. Fannie shares fell 25% yesterday and are at their lowest level since May 1996…

“Countrywide Financial Corp., which spent $2.4 billion in the past year to repurchase its shares, was forced to sell a chunk of its stock to raise money.

“Office Depot Inc., which bought back 5.7 million shares for an average price of $35 a share, said on its earnings call yesterday that it would like to buy its shares at the current price of $17.49, but can’t. Office Depot fell 7% yesterday.

“Home Depot Inc. said it will delay the rest of its massive stock buyback plan, while investors in Citigroup Inc. have turned nervous about the health of the bank’s balance sheet and capital levels, prompting management to say it isn’t in the position to repurchase shares…

“From the third quarter of 2002 to the second quarter of this year, more than $1.5 trillion of shares in non-financial companies has disappeared from the stock market through buybacks, mergers, or buyouts, according to the Federal Reserve. The number hit a peak during the second quarter of this year, when non-financial companies retired a seasonally adjusted net $192.5 billion of shares…

“Home Depot, for example, was downgraded in July by S&P to a triple-B-plus rating from A-plus. The rating agency specifically cited Home Depot’s plans to finance a $22.5 billion share buyback through the proceeds of an asset sale and $12 billion in debt as the main reason for the downgrade. Last week, Home Depot, which already spent $10.8 billion on buybacks in the first three fiscal quarters of the year, said it believes, ‘It is prudent to take a cautious stance with regard to the completion’ of the buyback program…

“Banks already are scaling back stock buybacks to conserve capital for other uses, like making loans to clients and setting aside money for bad loans. Further, the nation’s largest financial institutions may need to use their balance sheets to fund loans for private-equity deals, because anticipated buyers for those loans have dried up, leaving the banks on the hook.

“The capital issue is especially pressing at Citigroup, which recently saw a key measure of a bank’s capital cushion, known as Tier One, fall below its target of 7.5% for the first time in years. The bank has said that it doesn’t expect to repurchase shares until it restores its capital ratio in the middle of next year. While some have questioned whether Citigroup will have to consider cutting its dividend, the bank says it doesn’t intend to do so. People familiar with the matter say there are other steps it can take to shore up its capital position.”

Rethinking Buybacks

The AP reports that “Investors Need to Look Closer at Share Repurchases, as They Don’t Always Enhance Holder Value”:

“Repurchases, which some companies use borrowed money to pay for, don’t always reduce share counts significantly, according to S&P equity analysts and study authors Stewart Glickman and Todd Rosenbluth.

“For every 100 shares bought back during the study period from Jan. 1, 2006-June 30, 2007, 78 shares were added as a result of the exercise of stock options, shares issued to fund acquisitions, or for follow-on stock offerings…

“The study found that 20 billion shares were repurchased during the period, which contributed to a mere 22% reduction in the total outstanding stock — or 4.4 billion shares — for the companies that were actively buying back stock.

“Also, companies don’t always buy their shares at a low price. More than one-third of companies have seen their stock price fall since repurchasing shares — meaning they paid a premium. The stocks that dropped the most compared with the average prices paid for repurchases were Circuit City, KB Home, Pulte Homes, Centex, and Countrywide Financial, according to the S&P study…

“Most of the 423 companies that repurchased stock during the study period would have done better investing the cash in an S&P 500 index fund, or even more conservative holdings.”

Let’s build a list of companies recklessly squandering capital from the above articles and other known happenings:

Squandered Money List

  • Countrywide
  • Home Depot
  • Citigroup
  • Fannie Mae
  • Freddie Mac
  • Ambac
  • MBIA
  • Circuit City
  • KB Home
  • Pulte Homes
  • Centex
  • Toll Brothers

Obviously, that is a very short list of the worst offenders, as there is not room to list 423 companies. The most galling thing is that 78% of buybacks went for insider options. Shareholders got a mere 22% of the pie, and most of that was wasted.

For all this corruption and graft, shareholders look the other way as executives grant themselves and the boards they sit on enormous salaries and perks. To top it off, insiders were massively bailing on their own shares while squandering shareholder money. Nice work if you can get it.


November 26, 2007

The Daily Reckoning