by Will Ashworth | May 31, 2012 6:15 am
Share repurchases are so yesterday.
At least that’s the word according to Bloomberg and TrimTabs Investment Research, whose recent data would suggest share repurchases are at three-year lows while capital spending is hitting record levels.
It’s as if a switch went off in the heads of American CEOs, who finally realized it’s capital spending — not stock buybacks — that grow businesses. This kind of commitment is two years too late in my opinion, but better late than never. Let’s hope CEOs have the courage and conviction to continue along this path, because America’s recovery depends on it.
Bruce Bittles, chief investment strategist at Robert W. Baird & Co. says it best: “Investors and corporations themselves are best served when the cash is applied to improving capital investment, as opposed to buying back stock.”
It’s about time.
There are six options for capital allocation. These options include repurchasing shares, paying dividends, making acquisitions, repaying debt, capital expenditures and business development. In recent years, companies have opted almost exclusively for share repurchases, which has resulted in an impressive string of quarterly EPS increases.
Furthermore, some contend that the 95% increase in the S&P 500 since March 2009 wouldn’t have happened without the buybacks, because at the same time CEOs were buying, investors were dumping $167 billion in U.S. equity mutual funds.
That’s conceivable, I suppose. But it’s also possible that an equivalent investment in any of the other options would have achieved the same result.
Companies like Apple (NASDAQ:AAPL) have turned their back on America, and the announcement of a $45 billion dividend and share repurchase plan is supposed to make it all right. The real champions are companies who have been hiring Americans the past four years instead of wasting cash juicing earnings to increase already excessive CEO compensation.
Take BJ’s Restaurants (NASDAQ:BJRI) for example. Each location it opens requires seven managers — including a general manager and executive kitchen manager — and 150 hourly staff to assist in the operation of an 8,500-square-foot restaurant and brewhouse. BJ’s spends approximately $4.5 million to get a restaurant for customers. Therefore, each restaurant injects $4.5 million into the local economy before it has even opened its doors, not to mention creating 157 jobs, who all pay taxes. In the past three years, BJ’s Restaurants has opened 34 restaurants, injecting $153 million into local economies and creating 5,338 jobs.
Right in BJRI’s annual report is this sentence: “We currently do not have any plan to repurchase our common stock.” That’s because the company is too busy growing its business and creating jobs.
Peter Drucker, arguably the world’s top expert on management and leadership, believed the CEO’s job is to place the necessary bets for a company to be successful. Above all else, courage is vital to this process. Nowhere does he mention share repurchases.
The funny thing about share repurchases is they can be used effectively, but rarely are.
United Parcel Service (NYSE:UPS) announced March 19 that it was buying TNT Express for $6.77 billion in cash. It would pay for the deal with $3 billion in cash from its balance sheet, and the remaining $3.8 billion would come from new debt. The announcement then rambled on about the cost synergies of the combination. I have no doubt the deal makes synergistic sense, but management fails shareholders miserably. Here’s why:
Henry Singleton, founder of Teledyne — one of America’s most successful conglomerates — used share repurchases with military-like precision to grow his company. When shares were expensive, he used shares to acquire companies; when they were cheap, he bought them back. There was no middle ground for Singleton, and the strategy worked flawlessly.
UPS repurchased $12.7 billion of its stock over the past six years, paying an average of $68.93 a share. Let’s say for argument’s sake that it didn’t spend a dime buying back stock, opting instead to keep the cash in the bank. Today, UPS could pay for the deal in cash, and pay down $11 billion of its $12 billion in total debt.
Better still, UPS shares were trading at $78.41 as of the March 16 close and within 15% of an all-time high; an all-stock deal would have allowed it to use $12 billion of its treasure chest to pay down 100% of its debt. UPS still would have had $5.8 billion available to buy back stock if and when its shares traded below its November 1999 IPO price of $50, last seen in February 2009 and late 2001 before that. At the end of this hypothetical exercise, it would have a share count that’s 270.4 million, or 24%, higher. However, it would also be debt-free with cash in the bank and a business that’s much stronger in Europe as a result.
UPS, like so many companies, carries out share repurchase programs much like artists that use drip painting to create their works of art. Throwing paint at a canvas isn’t a plan; neither is buying back stock in a haphazard manner. It’s good to see CEOs might finally be doing their jobs and making the necessary bets to be successful — I can assure you that buying back stock isn’t one of them.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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