Buybacks, Bounces and Splats: Buying High, Selling Low
Rather than wait for the weekend Readfest posting there are a couple of sets of interesting stories you ought to be reading now and thinking about heading into the weekend, next week and for the duration. The duration of what you may ask ? Well that's the question - the duration of the current unpleasantness of course. It's apparantly really beginning to dawn on the MSM though not widely that all the pressures for stock buybacks have resulted in attempting to prop up company stock prices have resulted in paying top prices and now, re-financing and re-capitalizing, at lower prices. Though some, including us have been beating that drum for quite a while now.
- UPDATE: The WSJ chimes in (bigger excerpt below): Investors can usually count on share buybacks to help stabilize a stumbling market, but it's not happening this time around.
Below are seveal readings we've either recently collected and/or gone back and put here on the role of buybacks. Three things greatly.......many g's puzzle us:
- This has largely resulted, aside from the minor detail of perverse executive incentive programs that cause them to prop up the price while damaging the company, from hedge fund and buyout firm activism. Yet the capital that, for example, the banks squandered over the last several years is now desperately needed to offset what's likely to be continuing massive writedowns. In other words given their supposed financial acumen they put all these pressures on management to do a stupid thing if they understood how the deep structures were playing out. They're going to get hurt as badly as anyone because the cash they could have had in dividends or protecting their investments is gone...gone...gone. So instead of re-deploying it, or putting it under the mattress, it'll never be seen again.
- As part of this buyback effort not only has "excess" free cash flow been used but many companies have re-leveraged their balance sheets and are much more exposed to the pressures and perils of a downturn than they would be normally. In other words businesses are a lot more fragile than they should be, AND nobody is anticipating this in their outlooks as yet.
- Denial - while some commentary is appearing the necessary simple analysis combined with the facing of the facts hasn't really started. We've used the Kubler-Ross "Stages of "Denial" analogy several times but this looks like yet another case. The lesson for you is that whatever you read reflects only partial reality, so far.
Business, Buybacks and Fragilities
How banks frittered away billions When you take out your calculator, you see that these firms - Citigroup Merrill Lynch Morgan Stanley and UBS - have frittered away billions of dollars by selling their stock for much less than they paid for it. The biggest losers in the buy-high, sell-low game are shareholders of Citi, which had raised a total of $20 billion in two deals when Fortune went to press and was looking to raise more. First, that capital is precious when you need it - and you're never sure when you're going to need it, so you'd best keep plenty around. Second, that stock buybacks aren't necessarily good for shareholders, current conventional Street wisdom notwithstanding. The theory, promoted by "activist" shareholders and practiced by my employer, Time Warner, among others, is that buying back lots of stock enhances shareholder value. But as these cases show, buybacks can also erode shareholder value.
The Great Private Equity Cash Robbery of 2007 Well, as far as NotMakingThisUp is concerned, the most obvious thing missing in all of yesterday’s headlines was this: no share buybacks were announced by any major company before, during or after the brief morning sell-off. During the panic of October 1987, grey-beards will recall, the tape was clogged not only with headlines of trading-halts amidst the worldwide rush to sell, but also with a steady stream of share buyback announcements by U.S. companies. Coke, P&G and many others that week and in weeks subsequent to the Crash of ’87 used the substantial cash on their balance sheets to take advantage of the market dislocations that caused even the good stocks to be sold with the bad, and cannily bought their own stock back at deep discounts to its inherent worth. Could it be that the Great Private Equity Cash Robbery of 2007, in which previously healthy companies either “cleared” their balance sheets of cash—to use the euphemism employed by Steve Odlund, the Chief Cash Clearer at Office Depot—by buying back their own stock at bull-market peaks or faced the prospect of having it cleared for them by the Private Equity Cash Robbers?
Investors can usually count on share buybacks to help stabilize a stumbling market, but it's not happening this time around. Many companies bought back shares in recent years, leaving them with less ability to jump back in now. This time around, there are even higher hopes for such repurchases, given that the stock-market rout has made prices cheaper and falling interest rates make it less expensive to borrow money to buy stocks. But most companies aren't biting. Many bought back shares in recent years when they were much more expensive, leaving them with less ability and leeway with their investors to jump back in now.Investment bankers say executives are wary of committing to big, new share repurchases, in part because there is so much confusion about the outlook for the global economy both in the near term and long term. "When we were in a period when capital was plentiful and cheap, it's one thing, but now there are constraints on capital and a reassessment of operating strategies and the use of capital." For the past three years, share buybacks were the rage as low interest rates enticed companies to borrow money to buy back shares, a move that helps increase per-share earnings. Stock repurchases by S&P 500 companies amounted to $586 billion last year, more than double the amount of dividend payouts…
Market Drivers 3 (Buybacks):Investment, Hiring, Nah...Bonus, Bonus, Bonus !
This started out to be a straight-forward post on the shift from an economically driven market environment to a financially driven one. It's important - and is widely recognized if not diagnosed and analyzed
- that "liquidity" is behind a lot of what's been going on. It's turned into a three part set looking at the markets & the economics of liquidity (here ) and on the role of credit and leverage (here). The third leg of the stool that's pumping lots of cash into stocks AND pulling large/huge amounts of stock off the market is corporate buybacks using all that excess case from profits that aren't going into capital spending or hiring. Or dividends for that matter (personally I'd rather get the money back and decide for myself). Just to put it all in perspective, and maybe confirm that indeed things are a little unusual, take a look at the Fed data on "net equity issuance". It looks to me as if it started the '90s in neutral, grew slightly negatively until '98 (from stock options at technology firms ?) and turned back toward neutral. And then started sharply downward in '04 just about the same time the LBO buyout was coindicidently turning sharply upward.
WRFest 30Dec07(Business): Fragilities, Exposures & Soundness If it's not clear at this point we think the economy is slowing and seriously exposed to sudden & sharp disruptions as Housing and the Credit crisis worsen and it becomes more fragile. We also think that the Markets still haven't grasped this nor, definitely, is it reflected in pricing, earnings outlooks or valuations. Even on current course and speed with no major disruptions there's some serious re-thinking that needs to happen, at least IMHO. But if you start looking now and understand what's going on then there are going to be industries and enterprises that weather this storm, if not with style and grace. Finding them will be the trick and the trick to the trick starts with understanding the deeper structural fragilities that have been created by non-organic earnings and liquidity-driven buybacks. Well as is becoming a practice Paul Kasriel has already done the heavy lifting so we'll let his comments and charts speak for us. Here's the key point - on a macro level buybacks, real declines in profits and increased leverage indicate that business enterprises are very exposed to shocks if/when they come. In other words a hurricane will breach the dike and it'll take a well-founded company to manage the floods :). So pay careful attention to Paul's words and charts - think about 'em, 'cause they could be incredibly important.
Rocks, Ponds, Perverse Incentives: More on Credit Contagion
O.K. it's time to answer the question - while waxing eloquent about the credit crisis somebody asked the classic one - "what other asset classes ?". What I think they really meant was what in the bleep are you talking about. Well at the time a quick and dirty reply was ripped off that turned into a longish, well alright maybe more than that, comment on the credit crisis. That comment though was based on a multiple set of accumulated readings plus a little "model" of how the credit crisis is operating that's built up in my head and the occasional chart (previously put up here a couple of months ago ?). So earlier today we reviewed the bidding - to wit some selected readings and resources on the history, structure and nature of the evovling credit problems (here) and a deeper dive on the "rocks in the pond" credit contagtion model (here) which are the background to the reply.
Market Takes: the Stages of Denial
Belatedly this is the post that should have gone up earlier this week or over the weekend but time flies. The charts are thru the end of last week and are still valuable, and the points I want to make still accurate; perhaps more so in some ways. The goal here is to look at the recent market turmoil in light of both economic and financial realities (where the current state of the economy is discussed in Praise Be, the Data Has Saved Us (NOT): New Homes & Orders and financial conditions & Fed policy in Schadenfreude, Oh Schadenfreude: the Fed vs the Whingers ) Just to keep things in perspective instead of putting up the short-term ("trading") chart first we'll start with the longer-term ("investment") chart. With the side comment that it continues to amaze me how prior to mid-July all was right with the world of Goldilocks and now all the mainstream economists are beginning to accept the slowdown that folks like Kasriel and Roubini have been talking about for months and has been visibile in our charts for a long...long time. The reference to read is either the psycholgy/typology of denial, Denial , or the stages of denial, Kübler-Ross model , where we are arguably still locked into the first stage. Admittedly I'm amusing myself, and hopefully my readers, but there's real merit to the point. What we'll find when we look at the long-time chart of the S&P over the last four years is that, despite relatively weak real economic growth and very poor net job creation, is that the market boom's uptrend has basically not been beached - excuse me, another F-slip. I mean breached. And in the short-run the market appears to be struggling to convince itself that not only is denial correct but the diagnosis is completely wrong, i.e. the post Shanghai-Surprise mini-bubble is entirely correct. In fact various talking heads on bubblevision are arguing that with appropriate selection of strong, defensive sectors, or those with good int'l exposure and good, blue-chip companies that we're in a trading range and one should judisciosly pick from your shopping list at bottoms.