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Is This Buyback a Bad Idea?

Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I've made no secret of my general disdain for stock repurchase plans in lieu of dividends or capital appreciation through profitable growth.  

In fact, just three weeks ago I lamented the announcement of Zynga's (NASDAQ: ZNGA) ill-advised buyback as yet another irresponsible way the company plans to quickly burn through its enviable cash pile.  In Zynga's case, I argued the money could be better put to use in an effort to abandon its copycat ways and instead create a sustainable business through the development of unique, innovative games.

In other cases, such as NVIDIA's (NASDAQ: NVDA) recently-announced extension of its $2.7 billion stock repurchase plan, I've wholeheartedly agreed stock buybacks can be a responsible way to create shareholder value.  After all, I already believed shares of NVDA were fundamentally undervalued, especially considering the company's massive cash hoard.  With plenty of money for R&D and having put the building blocks in place to secure its spot in the mobile revolution, I was overjoyed when NVIDIA decided to continue returning capital to its shareholders by both extending its buyback program and initiating its first-ever dividend.

A New Buyback

Should we be skeptical, then, of Wednesday's new $50 million buyback announcement from Universal Display Corporation (NASDAQ: OLED)?  

Unlike NVDA, it's difficult to claim shares of PANL are cheap; the company's current P/E ratio of 107.5 looks more like an FM radio station frequency than a useful valuation benchmark.

In addition, last week the company reported a terrible third quarter in which it lowered revenue guidance after badly missing estimates on both revenue and earnings per share. However, as fellow Foolish investor Anders Bylund pointed out, while the stock is suffering in the short term, Universal Display's long-term business remains as strong as ever.  And, despite what might now seem a badly-timed call, I stand by my stance that shares of Universal Display should be bought.

Nonetheless, our impatient market loathes being told it needs to wait so sent shares of PANL tumbling to the tune of nearly 20% the day after its earnings announcement.

Lemons to Lemonade

Interestingly, PANL's drop is likely the reason for Wednesday's buyback announcement.  Looking back, this should come as no surprise as Universal Display management has a history of taking advantage of Mr. Market's wild swings.

Most notably, recall back in March, 2011, when the company completed a public offering of 5,750,000 shares of common stock at $46.00 per share.  PANL's message boards lit up as retail investors were baffled, wondering why their relatively cash-rich company would need to raise over $264 million.

Fortunately, some clarity was offered a few months later in the form of Universal Display's $105 million acquisition of 1,200 OLED patents from Fujifilm.  

But investors still wondered: What was to become of the other $159 million from the offering?  Did Universal Display have anything else up its sleeve?

The answer actually came two months ago at the Deutsche Bank dbAccess Technology Conference.  In response to a question about how the company planned to use its then $249 million in remaining cash, Universal Display CFO Sidney Rosenblatt stated "I don’t see any large acquisitions.  When we raised the capital last spring the portfolio that we had in mind was the Fujifilm portfolio and to be honest we really didn’t know what it would cost us to get it.  So we don’t really have any significant cash needs."

The Verdict

With no significant cash needs and shares of PANL currently trading at a 50% discount to the 2011 offering price, why shouldn't Universal Display reabsorb some of its shares?  Even after its third quarter loss, $50 million is a paltry sum compared to the company's remaining $239 million in the bank.  If Universal were to execute its buyback at current levels, it could reverse nearly 40% of last year's dilution while using less than 20% of the offering proceeds.

Say what you will, but I think Universal Display deserves a round of applause for making the most of a (temporarily) bad situation.

Steve Symington owns shares of Universal Display and NVIDIA. The Motley Fool owns shares of NVIDIA and Universal Display. Motley Fool newsletter services recommend NVIDIA and Universal Display . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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