This article originally appeared in the NZ Herald.
Investors love share buybacks. The announcement that a company will purchase its own shares is usually greeted with great enthusiasm and a share price appreciation.
However, support for buybacks is far from universal. A number of studies have criticised these repurchases because they can have a negative impact on the long-term financial health of a company, particularly if they are debt funded.
These schemes may also indicate that the management team has run out of investment ideas.
Is this criticism justified? Do NZX-listed companies have too many share buybacks?
Companies have three broad options regarding their earnings – they can reinvest them back in the business, they can distribute these earnings as dividends or they can have share buybacks.
An analysis by William Lazonick in the Harvard Business Reviewrevealed that the companies in the S&P 500 Index for the 2003 to 2012 period used 54 per cent of their earnings to buy back their own shares, 37 per cent were distributed as dividends and only 9 per cent was reinvested back in the business.
Lazonick wrote: “The buyback wave has got so big that even shareholders – the presumed beneficiaries of this corporate largesse – are getting worried.”
He quoted Laurence Fink, the chairman and CEO of the world’s largest investment manager, BlackRock, as saying: “It concerns us that, in the wake of the financial crisis, many companies have shied away from investment in the future growth of their companies. Too many companies have cut their capital expenditure and even increased debt to boost dividends and increase their share buybacks.”
Buyback activity by S&P 500 companies has continued to increase from the US$384 billion spent in 2012. In 2013 this group of 500 companies repurchased US$478 billion of shares followed by US$566 billion and US$569 billion in 2014 and 2015 respectively.
The FactSet Buyback Quarterly reports that 58 per cent of the 2015 free cash flow of S&P 500 companies was used to finance buybacks while 70 of the 500 index companies were the subject of activist shareholder campaigns to return cash via dividends and/or buybacks. FactSet revealed that 31 of these 70 activist campaigns were successful, a record high.
The definition of success includes: a special one-off dividend, an increase in the regular dividend, the announcement of a new repurchase programme or the expansion of an existing repurchase programme.
The largest 2015 buybacks were Apple, with US$39.7 billion and Microsoft, US$16.8 billion.
Apple had a negative sharemarket return of 15.5 per cent in 2015 while Microsoft had a positive total shareholder return of 32 per cent.
Apple has raised only US.1 billion of equity from the public – through its 1980 IPO – yet it bought back US$39.7 billion of shares last year. These share buybacks have been a major contributor to Wall Street’s recent strong performance even though many commentators argue that they can have a negative impact on long-term performance.
A number of studies have argued that buybacks are more about the interests of senior executives than the listed companies. The highest paid executives in the United States often received more than 50 per cent of their compensation in shares, share options or share awards.
Buybacks usually boost share prices and, therefore, the wealth of senior executives. So senior executives are highly motivated to promote share repurchase schemes and there can be serious conflict of interest in this regard, particularly when one person is both chairman and chief executive of a company.
Lazonick noted that the CEOs of the 10 largest US repurchase schemes between 2003 and 2012 received an average 58 per cent of their compensation in the form of shares. Ironically, only three of these 10 companies outperformed the S&P Index during this 10-year period.
There is also a strong argument that the timing of these repurchases is poor; companies aggressively purchase their shares during bull markets and cut back sharply in bear markets.
The buyback debate has received more media attention this year following an analysis by Robert L. Colby, a retired investment professional. Colby argues that Yahoo would be better off today if it had invested the US$6.6 billion it spent on buybacks between 2008 and 2014.
He also argues that McDonald’s would be better off if it had invested most of the near US$18 billion it has spent on share repurchases since 2008.
Last year Moody’s downgraded McDonald’s unsecured debt because of plans to increase its borrowings, partly to fund share buybacks. Colby told the New York Times that he was not totally against buybacks but “they are being practised far more broadly and without as much analysis as there should be”.
Lazonick and Colby aren’t the only ones to criticise share buybacks. Hyun Song Shin, head of research at the Bank of International Settlements, told Reuters this week that 57 of the world’s largest banks had spent US$1.73 trillion on share buybacks between 2007 and 2014 while they retained only US.4 trillion of earnings.
Shin believes that the US$1.73 trillion could be better used to strengthen bank capital or to lend. He added: “If banks feel constrained by regulation then ploughing more of the bank’s profits back as retained earnings and not dissipating its capital through share buybacks solves the problem.”
The accompanying table lists all the share buybacks by New Zealand listed companies since the end of 2014. The $362.7 million figure is extremely modest both in absolute and relative terms and indicates that buybacks have had a limited impact on the market’s performance.
New Zealand buybacks since December 2014 represent less than 0.4 per cent of the domestic market’s current capitalisation, whereas repurchases by S&P 500 companies over the same period represents more than 5 per cent of the US sharemarket’s total value.
A quick look at the New Zealand list, which is dominated by Contact Energy with $100 million of buybacks, Tower $71.2 million, New Zealand Oil & Gas $63.4 million, Nuplex $36.1 million, Spark $34.7 million and Mighty River Power $24.1 million, clearly shows that New Zealand chief executives are not enriching themselves through these schemes, mainly because they have very modest shareholdings.
In addition, there are far fewer conflicts of interest because no one is both chairman and chief executive of a company at the same time.
We also have fairly limited shareholder activism, with the New Zealand Oil & Gas buyback the only one that can be identified as a direct response to shareholder pressure.
Not all of the transactions classified as buybacks by the NZX can be deemed to be repurchases in the classical sense of the term. For example, Mykco (formerly known as Mykris) sold its main operations to its controlling Malaysian shareholder for a notional price of $12.9 million and in return the Malaysian parent’s shareholding in the NZX-listed company was cancelled. No cash changed hands.
Mykco is now a listed shell with a total sharemarket value of only $870,000.
New Zealand share buybacks are far less regular than they are in the United States and there is no suggestion that their primary objective is to boost the wealth of senior directors or board members.
In addition, our share buybacks are far less aggressive than their equivalents in the United States.
For example, Infratil, Just Water International and Kingfish all announced share buybacks in 2015 or early this year yet none of them have yet purchased a single share, according to NZX data.
Disclosure of interest: Milford Funds Ltd. holds shares in many of the companies listed in this article.
Disclaimer: This article originally appeared in the NZ Herald and is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.