In­vestors should be an­gry at the cost of share buy­backs

The Pak Banker - - OPINION - An­thony Hil­ton

IF, amid much fan­fare, a com­pany an­nounced a £1 bil­lion in­vest­ment or launched a £1 bil­lion takeover of a ri­val and then, within 15 months, wrote off pretty well half the value of that in­vest­ment, ques­tions would be asked, share­hold­ers would be fu­ri­ous and there would be pres­sure for some of the di­rec­tors to quit. But if a com­pany puts in place a share buy­back and then a few months later is­sues a se­ries of profit warn­ings lead­ing up to a mas­sive cut in div­i­dends, the net re­sult of which is for the shares pretty well to halve from their peak, no one seems to care much.

When you look at all the con­tro­versy around Rolls-Royce - though there is a lot of up­set about the profit warn­ings, the loss of div­i­dend and the fact that the com­pany should have stum­bled so badly - the role of the board in agree­ing to a share buy­back which clearly should never have taken place has not re­ally fig­ured. It did not used to be like this: as one fund man­ager was heard to rem­i­nisce last week, back in the day when Mer­cury As­set Man­age­ment ruled the in­sti­tu­tional fund man­age­ment roost, if a board bought its own shares and then had to slash its div­i­dend a few months later, it would have been called in, given a se­ri­ous dress­ing down and pre­sented with the choice of a 50% pay cut or res­ig­na­tion - and some­times both.

And de­servedly so - buy­ing shares which then al­most halve in value is a mas­sive and to­tally un­nec­es­sary squan­der­ing of share­holder's funds. The si­lence on the is­sue th­ese days un­der­lines how even UK in­sti­tu­tional share- hold­ers are not re­ally in­ter­ested in UK eq­ui­ties any more in spite of the ef­forts by the Fi­nan­cial Re­port­ing Coun­cil and the In­vest­ment As­so­ci­a­tion to re-en­er­gise them.

Pen­sion fund and in­sur­ance com­pany hold­ings have been slashed - they hold fewer eq­ui­ties any­way and within that equity al­lo­ca­tion they hold fewer UK stocks. For­eign in­vestors who now hold far more shares in Bri­tish com­pa­nies than they once did, don't en­gage much. If they do any gov­er­nance at all then they fo­cus their ef­forts where they think they will get a more spec­tac­u­lar up­lift if they suc­ceed - which is in emerg­ing mar­kets or on the oc­ca­sional scan­dal in the US or Europe.

Buy­backs are an Amer­i­can idea of course - it was against the law for a com­pany to buy its own shares in this coun­try un­til the Eight­ies - so it is fit­ting that though Rolls-Royce is in the frame to­day, Amer­i­can busi­nesses have lost even more. As­so­ci­ated Press last week pub­lished an anal­y­sis based on re­cent Fac­tSet data with a league ta­ble of the com­pa­nies which had the big­gest pa­per losses from buy backs: IBM came top with $ 9.8 bil­lion (£ 6.8 bil­lion), fol­lowed by Qual­comm with $7.4 bil­lion and Amer­i­can Ex­press at $4.1 bil­lion.

The anal­y­sis should have come with a health warn­ing that since the oil price plunge, it is best not even to look at what's hap­pened to the oil ma­jors. In sum­mary, in the past three years vir­tu­ally all Stan­dard & Poor's 500 com­pa­nies got their tim­ing wrong. The com­bined losses as a re­sult for th­ese buy­backs is $126 bil­lion, or 15% of what was paid out.

(Note the boards man­aged to lose this money even dur­ing a time when the Amer­i­can mar­ket has been buoy­ant.) But the big­ger truth is that it is time for a re-think on share buy­backs, and if that is too much to ex­pect per- haps share­hold­ers and an­a­lysts could at least stop and think be­fore cel­e­brat­ing ev­ery time a buy­back is an­nounced.

They al­ready un­der­stand that three-quar­ters of takeovers de­stroy value for the bid­ding com­pany and they should ap­ply the same scep­ti­cism to buy­backs which af­ter all em­ploy the same logic - that they can make more money for share­hold­ers from buy­ing shares than they could from in­vest­ing it prop­erly in the ex­pan­sion and de­vel­op­ment of the busi­ness. The only time a buy­back creates value is if the shares which are bought are trad­ing below their in­trin­sic value. Iron­i­cally on the oc­ca­sions when that is the case com­pa­nies ei­ther don't have the spare cash to con­duct such an ex­er­cise or the board finds the pre­vail­ing con­di­tions too scary and wants to hold onto the money.

There is of course a per­verse in­cen­tive to do buy­backs if you are se­nior man­age­ment. Most of them th­ese days are on some form of in­cen­tive scheme and more of­ten than not part of their pay­out is linked to growth in earn­ings per share. When prof­its are flat, the busi­ness is go­ing nowhere and man­age­ment clearly has no idea what to do, then a buy­back be­comes its "get out of jail" card. Shrink­ing the num­ber of shares in cir­cu­la­tion au­to­mat­i­cally in­creases the earn­ings per share of the busi­ness as the un­changed level of prof­its are con­cen­trated in fewer shares. When all else fails, it is one way to make sure those in­cen­tive bonuses keep flow­ing.

Newspapers in English

Newspapers from Pakistan

© PressReader. All rights reserved.