Are Stock Buybacks a Waste of Money? (Revisited)
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In a previous article I discussed how and why companies purchase their own shares of stock. I also outlined better ways to deploy the cash such as paying a dividend to help boost positive perceptions from the market thus increasing share price appreciation, discussed how money used for share repurchases could be used to acquire businesses and develop technologies to boost overall fundamentals, and indicated that cash could be used to pay down debt.
One of things I like about the Motley Fool Blog Network is that it has opened up a forum for investors to debate and learn from that debate. I dare say that this article was a great deal more controversial than I thought it would be. One reader made a statement that made an impression on me and made me decide to take a second look at the issue of stock buybacks. While “fidgewinkle” agreed that “sometimes share buybacks are a bad idea” he also had this to say about taking on debt to make stock buybacks:
"Others have already made it obvious that stock buybacks increase shareholder equity in the company since there are fewer shares outstanding. However, they haven't mentioned how ignorant you're suggestion that companies pay down debt instead is. For the companies you've mentioned, the rate on their debt is down below 3%. If they expect a greater return on their own stock, like your Buffet example, they should buy their own stock instead of paying down debt. Intel explicitly borrowed that money to buy back shares of their stock since the interest rate was lower than their dividend rate."
I respect the opinion of my readers. This statement led me to wonder if I was truly valid on the stance that “Stock Buybacks are a Waste of Money” especially with Intel (NASDAQ: INTC).
In 2011, Intel decided to issue $5 billion dollars in senior notes “primarily to repurchase shares of our common stock pursuant to our stock repurchase program, and for general corporate purposes.” Since Intel pays a dividend on their common shares, part of the analysis involves comparing the yearly interest expense to the decrease in dividends as a result of the repurchased shares. If a dividend reduction exceeds the corresponding increase in yearly interest expense then money is saved (see table below).
*Source: Intel’s 2011 Form 10-K Page 72
According to Intel’s Consolidated Statement of Stockholder’s Equity they spent $2.2 billion dollars on share repurchases in 2011. The net amount of shares after reissuance due to employee incentive plans reduced for 2011 was 511 million shares. If you take 511 million shares and multiply $0.7824 per share paid in 2011 you arrive at almost $400 million a year reduction in dividends. The difference between reduced dividends and the interest on the debt is roughly $233 million. With a dividend rate of $0.90 per share that amount goes to $460 million in dividend reduction with a net savings of $293 million for 2012 for those retired shares. In this instance going in debt to repurchase shares saved Intel money.
However, I still have three counterpoints to offer based on the $5 billion in senior notes:
1) The proceeds from the $5 billion debt offering could have been invested in research and development to come up with a chip that could help them better compete in the tablet market.
2) The proceeds from the $5 billion debt offering could have been used as a special dividend offering shareholders a more direct benefit.
3) Last but certainly not least is that the continual piling on of debt to repurchase shares could lead to vast amounts of interest expense that will choke the company’s cash flow. This option would become less viable if interest rates rise.
Another company that is going in debt for “general corporate purposes and share repurchases” is homebuilder NVR (NYSE: NVR). They announced a debt offering of $600 million dollars at 3.95% per year. This equates to roughly $24 million dollars a year in interest. NVR pays no dividend so it is not saving money from that standpoint. NVR’s P/E ratio stands at 32 making the stock overvalued so they are also paying too much for their shares. Since the industry in which they operate is not very stable, the proceeds from the debt offering would be better utilized for general corporate purposes.
Cheesecake Factory (NASDAQ: CAKE) spends a huge percentage of its cash flow on share repurchases to the detriment of their balance sheet. In 2011 their share repurchases amounted to 145% of free cash flow. Their cash to stockholder’s equity was down from 18% in 2008 to 9% in the most recent quarter. I like companies to be good stewards of cash. Cheesecake Factory would be better off to conserve cash for more difficult times. They could also invest in their own business or pay it back to shareholders in the form of a dividend. It looks like Cheesecake Factory recently initiated a dividend of $0.48 per share per year so some of the cash is coming directly to the shareholder.
Once again I like to thank my readers. If it wasn’t for them I wouldn’t be here. I also like to thank them for giving me the inspiration to re-examine this issue further. Companies that go into debt can save money by retiring shares that pay dividends provided that the interest expense incurred is lower than the amount saved by the dividend payout reduction. However, companies that continue to pile on debt for this purpose could choke out earnings without ever increasing interest expense. Investment in research and development is an excellent way for a business to become more competitive. Payment of a dividend provides a direct benefit to the shareholder as well. Conserving cash helps make a business more competitive in lean times. With that said, I still feel overall that stock buybacks are a waste of money and do not provide a direct benefit for the shareholder.
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