Will buybacks put a floor under the stock
market? In the quarter after the 1987 crash, there
were nearly 800 new buyback announcements.
Already, IBM has weighed in with a whopper.
The buyback monster
By Matthew Schifrin
HISTORICALLY, when stocks are high,
corporations sell stock to the public. It's the old
"When the ducks quack, feed 'em" syndrome.
But last year and in 1995, amidst a roaring bull
market, American businesses bought back more
shares than they sold to the public. In fact,
corporations have been heavy buyers of their own
shares through most of this bull market.
Will buybacks repair the damage after the 1997
selloff? IBM has already thrown another $3.5
billion into its buyback hopper. If the 1987
precedent holds and the market stays down, there
will be many more such announcements: In the
quarter after October 1987, there were 777
announcements of new or increased buybacks by
U.S. companies, according to a study by Rice
University Professor David Ikenberry. Size of the
pot: $45 billion. Such buybacks certainly helped
the subsequent recovery.
These buybacks don't just enhance individual
stocks. By reducing the overall supply of equities
they put upward pressure on all prices. Indeed,
24 of the 30 stocks in the Dow Jones industrial
average have announced buybacks since 1995.
If the 1987 precedent holds and
the market stays down, there will
be many more announcements.
There were signs before the recent drop that
buybacks were slowing. Through the first three
quarters of this year there were 980
announcements of $130 billion, according to
Securities Data Co. Actual buybacks, compiled
by S&P's Compustat, however, were only $72
billion, which was exceeded by new stock issues
of $92 billion. So after two years in which
buybacks exceeded new offerings, the balance
had swung the other way.
With the recent drop, however, the pace of
buybacks could increase.
A bigger question remains: Do all these buybacks
make sense?
Buybacks are certainly tax-efficient. When a
company pays a cash dividend, the tax collector
hits the income stream twice-once when the
company earns it, again when the stockholders
get it. That means a big company must earn $3 to
put $1 in aftertax income into a high-bracket
shareholder's pocket. If the money is used to buy
back shares, the remaining shareholders are
rewarded with a proportionately higher ownership
interest-and this kind of "dividend" is taxed only
when the company earns it.
Buybacks serve other useful purposes. They help
counteract the dilution that results from generous
stock option plans and from acquisitions paid for
in stock. And they provide support for the stock
price at a time when investors everywhere are
sensitive to relative market performance.
But there are also negatives. Should a company
support its own stock? And doesn't management
have anything better to do with the money?
In the early 1980s IBM began a big buyback
program. Between 1985 and 1990 it bought back
nearly 50 million shares, shrinking its common
capitalization by 8%. The buybacks ended with
the collapse of IBM's stock in 1991. Before the
decline was over, IBM was down 75% from its
high.
Why, at a time of huge expansion of the computer
industry, didn't IBM have better uses for its cash?
As it turned out, the aggressive buyback program
was a sign of weakness for those who cared to
read the signs. Yet today, when IBM lags in the
crucial PC business, it is again buying back gobs
of its own stock.
In 1987 and 1989, when its stock was often
selling at three times its present level, Digital
Equipment Corp. was actively buying in its
shares. Had management waited, it could have
bought three times as much stock for the same
price.
Buyback advocates can point to huge successes.
Capital Cities Communications bought back
aggressively during the 1970s bear market. From
1972 to 1976 Teledyne Chairman Henry
Singleton bought back about two-thirds of his
company during a sick market: When the market
recovered, Teledyne took off, climbing from $9
to $70 between 1975 and 1977. But mark this:
These buybacks were made in a bear market
when few had the guts to invest in their own
companies.
Coca-Cola, Philip Morris and McDonald's are
recent examples of companies with consistent
large buyback policies. They have been great
long-term investments. In Coke's case, its
repurchases of 1 billion shares from 1984 to
1996 were enough to boost annual
earnings-per-share growth to 18%, versus a 14%
increase in its net income. But neither Coke nor
Philip Morris is in a capital-intensive industry;
stock buybacks are a legitimate way for them to
use free cash flow.
"Many institutions push us to buy back stock,"
says Kurt Landgraf, DuPont chief financial officer,
"especially since we have a strong balance sheet
with $2 billion in cash. My view is that buybacks
are the last alternative." DuPont has done
buybacks for specific purposes: When Seagram's
big block of DuPont stock was available, the
company grabbed it, at a bargain price. Later it
used buybacks to reduce the diluting effect of a
20% investment in Pioneer Hi-Bred.
The market's buyback floor . . .
Sources: Securities Data Co., Standard & Poor's
CompuStat.
Record stock issuance
usually means an
overheated market.
But until recently,
buybacks have
exceeded offerings.
. . . may be wearing thin
But what's good for some companies isn't
necessarily good for all. Should McDonald's be
supporting its price with big open-market
purchases while its basic business is lagging?
Or take HFS, the high-flying franchise company.
A year ago, after saying it would buy corporate
relocation company PHH Corp. for $1.8 billion in
stock, its shares dropped 25%. HFS responded
by buying back more than 2.5 million shares to
prop up its price so it could complete the deal.
HFS was buying back at over 50 times earnings.
Was that good for its shareholders? HFS sells for
less than it did before the PHH acquisition was
announced.
There's no question the fad has gotten out of
hand. "We have never had a stock market trade
at such a high value relative to replacement cost
[of assets]," says Richard Howard, portfolio
manager for T. Rowe Price's Capital
Appreciation Fund. "[In the circumstances] it is
extremely unlikely that stock repurchases will do
anything to add shareholder value."
They can, however, make managements look
good for a while. Consider ailing Storage
Technology. In October the Louisville,
Colo.-based data storage outfit was attacked by
one of its large shareholders, who told
management, in effect: "Buy back $1 billion of
stock, or we'll throw you out."
The shareholders are former Mesa L.P. managers
David Batchelder and Ralph Whitworth.
Newcomers to the stock, they are not interested
in management's strategic plan to improve
operations. They want quick action. That annoys
longtime shareholder Seymour Licht, who got into
Storage a decade ago as a creditor in its
bankruptcy. "I didn't hold on to this investment
for management to prove its stock-buying
expertise. I invested for the memory business," he
says.
Batchelder and Whitworth proposed Storage
borrow some money to buy back the stock.
Management quickly gave in and announced an
$800 million buyback. But should a marginal
company that's in a tough industry be
accumulating debt unnecessarily?
"Are buybacks really bullish if
company managements are
buying in stock at their alltime
highs?"
They of course were simply parroting Wall Street,
which loves buybacks. The banking industry has
also embraced them. According to Salomon
Brothers, banks' internal rate of return on
buybacks has dropped from 44% to about 19%.
Some banks like CoreStates Financial, SunTrust
and Huntington Bancshares are even borrowing
to buy back their shares. This at a time when
banks sell at huge premiums to their book value.
"These share buybacks don't change the
economic value of these institutions or improve
their franchise value," complains Salomon bank
analyst Carole Berger. "They merely increase the
risk to shareholders during the next credit cycle."
She notes that the capital ratio is starting to drop.
"In 1990, when it hit the fan," she recalls, "there
was no such thing as too much capital."
"Are buybacks really bullish if company
managements are buying in stock at their alltime
highs?" asks James Stack, publisher of a market
newsletter, Investech. "Where were all these
buyback programs in 1990 and 1991?"
If you believe in perpetual prosperity, all
buybacks make sense. But we suspect a lot of
managements will wake up some day and wish
they had some of that money back. It's easier to
shrink capitalization than raise money when it is
badly needed.
Tables:
Buyback stars
Buyback dogs Nino--Act II
From Forbes November...97
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