Jan

23

 WSJ today has an article that's critical of companies that do big share buybacks. It features quotes from Chanos, who says he's shorting some of the buyback companies. Much of it seems wrong to me.

HPQ is cited as an example of a buyback disaster — "if only" HPQ had just invested in real opportunities instead of those buybacks. I thought though that HPQ's problem wasn't the buybacks, but the high-priced acquisition of a software company that turned out to be fraudulent. Obviously they would have been much better of if they had used that $15 billion to buy back shares.

The main target of the article though is IBM, which seems like a particularly bad choice. IBM's earnings have grown by a factor of 3 over the last 10 years while its share count had dropped 35%. Furthermore, IBM is one of the few companies to have reduced its share count even during the 2008/2009 period–the count went 1385, 1339, and 1309 million in years 2007, 2008, 2009.

anonymous writes: 

I think your analysis is quantitatively accurate, but the typical bottoms-up analyst has a much shorter lookback period than you do, 5 years at most, and with good reason.

The fact of the matter is that IBM has had extremely low/negative "organic" revenue growth for several years. The CSFB analyst has made the most consistently cogent representation of this argument, and "FCF conversion attributable to shareholders" (FCF post-financing, post-M&A) has been ~70% of earnings and falling … and FCF conversion has deteriorated every year since 2009 as a fundamental analyst/PM myself (of internet stocks).

I would never use a lookback beyond the current management team, and probably 3 years or less. I suspect Chanos keeps an extremely close eye on FCF conversion combined with -ve organic revenue growth, and sees aggressive corporate buybacks within a rapidly deteriorating fundamental backdrop as a form of management corruption, in which management chooses to invest excess capital in juicing their own stock options, instead of reviving the company's longer term prospects. This is endemic of "blue chip" tech conglomerates that no longer know how to generate organic growth.

I am not quite as familiar with HPQ but i strongly suspect it's a similar thesis.  I was totally bewildered by Buffett's decision to load up on IBM in 2011 as were a lot of people who covered IBM. It violated every one of Buffett's own rules.

Side comment: since Chanos is compensated on "negative alpha" instead of absolute return (i.e. if the market is +20% and Chanos's short portfolio is only 10% against him, he is "up 10 percent on the year") he has the luxury of fighting these longer-term wars against these kinds of companies.  It's very hard to fight a stock that's buying back 10% of their float per year, which probably makes them more attractive to shorts who can take a longer view.

Gary Rogan writes: 

Stocks (or rather companies) that can't go organically but don't shrink are like perpetual bonds, but with an upside option in that someone can buy them for the cash flow. At the right P/E they can make a lot of sense.

 


Comments

Name

Email

Website

Speak your mind

1 Comment so far

  1. Orson Terrill on January 24, 2014 4:53 am

    There are many caveats to buybacks. Several deals have been using buybacks in such a way that one should at least be concerned about the longevity, and the intent, of those programs. As an example: Blackstone purchased 6% dividend “preferreds” in CROX*, with a conversion at $14.50. That was barely 10% above the closing price, yet part of the announcement was that CROX would be free to remove 30% of shares outstanding as part of a share repurchase plan. The implied 20% alpha branded with Blackstone’s good name; that sent the stock well over $14.50 with no delay.** There is also no requirement for them to actually repurchase the shares, and of course no guarantee that they won’t be refloated even if they do.

    These buyback cash flows absolutely need to be qualitatively, and quantitatively, explored. Every regulatory disclosure needs to have the character of the wording examined, and compared to less official investor relations material to compare divergences in wording, and where those divergences may or may not lead (I spend quite a bit of time examining wording, sentence structure, and the semantic order in which information is presented to “discover” what is not being said directly. I’ll even download the PDF documents from the company website and see/check the names on those who created them, if there, and the date of creation, if there, and any notes the dopes forgot to delete…if there) For all practical purposes, some companies are completely looting the balance sheet for buybacks; wiping out billions to earn tens of millions more in bonuses based dubiously on EPS growth and share price. These may be the most opportune. At the same time, I am partially sympathetic; what is the purpose of a company for a shareholder/owner?

    The upshot is if you believe that a company is committed regardless of the economics, then it creates an opportunity from putting a floor in the price. For example, buying deep in the money far dated calls (deep enough such that the premium paid above current share price is minimized) and selling at the money/slightly out of the money nearest dated calls creates an opportunity to own a business dealing in your own risk inventory…. Selling premiums to those optimistic about the implications of a buyback program, with downside partially insured by the incentives of the board and executive suite to “guarantee” a floor in demand.

    * = CROX is partially, and hilariously, a currency fund. They are “hedging” by going short the dollar in every currency they do business in through swaps. HA! A gamble within gamble.

    ** = http://www.forbes.com/sites/maggiemcgrath/2013/12/30/crocs-nets-200-million-investment-from-blackstone-announces-stock-repurchase-program/

Archives

Resources & Links

Search