MorningWord 10/1/12: Stealing From Peter To Pay Paul

by Dan October 1, 2012 9:01 am • Commentary

MorningWord 10/1/12:   When previewing NKE’s Q3 earnings report last week we mentioned that we thought it was curious that the company, the week before their report, announced a share repurchase program of $8 billion, double the previous one.  I am by no means an expert in corporate governance, but from a purely anecdotal standpoint, I would have to guess that a disproportionate amount of these sorts of announcements do not come out while the company is in its “quiet period”, essentially closing the books for the quarter.  Conspiracy theories aside, the Stock opened up nearly 3% on the announcement on Sept19th, only now to sit 5.5% lower from those highs.  While the company intends to buy a lot of shares, investors used the enthusiasm to sell.

NKE 10 Day Chart from Bloomberg

Over the weekend there was an article in the WSJ suggesting, Beware All Those Buybacks.  Nothing particularly earth-shattering, but a good reminder that while the mechanics of buybacks are usually in shareholders’ best interests, many corporations use their corporate coffers to manage earnings, which compared to dividends is likely to be a far less attractive approach to returning cash to shareholders.

Here are a few quick highlights:

-During the second quarter of 2012, companies in the Standard & Poor’s 500-stock index repurchased nearly $112 billion of their own shares, up 32.6% from the previous quarter

-investors have to make sure that is actually happening. Many companies buy back shares purely to offset the issuance of new ones as part of compensation packages, says Andrew Lapthorne, head of quantitative analysis at Société Générale.

-On July 18, for example EBAY reported it had bought back $355 million of stock during the second quarter and would repurchase $2 billion additional shares. The primary objective, the company said, was to offset the additional shares being issued as compensation.

-On average, buybacks haven’t been a great way to boost shareholder value, says David Zion, an accounting analyst at Credit Suisse.  From 2004, when companies first were required to disclose monthly share repurchases, through the end of 2011, 31% of S&P 500 companies have seen the value of those shares fall, Mr. Zion says. And just 36% have returned more than 7%.

In Enis’s Q3 preview of AZO on Sept 18th, he highlighted the company’s history of buying back their stock, using most if not all of their operating free cash flow to do so, while also raising debt to buyback their stock since 2007.  The stock has been a monster since the lows in 2008, up almost 300% in that time period, and with a tiny float, short interest at about 4%, a whos who of long only investors, plus some famed activist hedge funds, this stock seemed like it was built for these sort of corporate shenanigans.

Make no mistake about it, you’d rather own stocks, where the company sees the same value at current levels that you do, but as was the case with EBAY mentioned above, and FB’s announcement to do the same to offset additional shares to be offered for future employee compensation is just a simple corporate shell guy, stealing from Peter to Pay Paul so to speak.