The theory about shareholder repurchases is that they are a tax-free way for companies to distribute excess cash to shareholders. And proponents of buybacks like them because it increases your pro rata share of a business without having to cut a check. Who wouldn’t like it? It’s like owning a one-tenth share of a private company and being offered one of the other nine shares for free.
But real life doesn’t work that way. There’s always a catch. Investors should understand that share repurchases aren’t a free lunch.
Biotechnology giant Amgen (NASDAQ:AMGN) is one of the top 10 holdings of the PowerShares Buyback Achievers Portfolio (NYSE:PKW), an ETF that owns the stocks of companies repurchasing more than 5% of their outstanding shares in the past 12 months. Since the fund’s inception in December 2006, Amgen has been a top holding in three of the past five years. It’s a frequent — if not repeat — buyer of its own stock.
On Dec. 8, Amgen bought 83.3 million shares of its stock at $60 per share in a modified Dutch auction. Not surprisingly, this price was at the very top end of the range ($54 to $60) that it was prepared to pay. Why show any restraint in the price you pay when it’s other people’s money?
And I’m not talking about excess shareholder cash here. I’m talking about a much more egregious situation. You see, Amgen borrowed the money, citing a need to preserve cash for future acquisitions and to support its new bone-building drugs Xgeva and Prolia. Obviously the deleveraging of the past four years means nothing to Amgen management.
For this reason, I believe the following hypothetical scenario could happen in the next two years:
- Amgen management will announce that growth has stalled and it is making a massive $40 billion acquisition.
- To pay for the acquisition, it will issue 500 million shares in stock to go along with $15 billion in cash.
Here’s what you’ll get for their efforts:
- $21 billion in debt — 200% higher than in 2006.
- $10 billion in cash — approximately half the amount held at the end of 2011.
- 1.36 billion shares outstanding — 58% higher than today, and the highest share count in its history.
- A 50/50 chance at best that the acquisition will be a success.
- A share price around $50 — 30% lower than today.
I’m not providing an assessment of Amgen management or the company itself. Rather, I’m simply offering up a possible scenario for the future given Amgen’s previous actions. Am I saying unequivocally that this will happen? Absolutely not. But it’s entirely feasible, and that alone should worry shareholders.
Especially when the alternative could have been to say no to any new debt, no to any acquisitions except those of a tuck-in nature and yes to the delivery of excess cash (sitting at $20.6 billion as of Dec. 31) in the form of periodic special dividends.
Shareholders deserve better.
From the end of 2007 to the end of 2011, Amgen repurchased 312.6 million shares of its stock at an average price of $55.76 a share. During this time, its stock traded at an average of $52.84 (going as high as $66.51 and as low as $39.16). Amgen management spent more than $17 billion in shareholder cash, and that was the best it could do?
Don’t be fooled by the 16% jump in its share price since Dec. 8. Much of it was management-induced.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.