by Will Ashworth | September 28, 2012 9:45 am
America’s largest companies stepped up to the plate in the second quarter with repurchases of almost $112 billion in stock, the highest amount since the third quarter of 2011, when S&P 500 companies bought back $118 billion. Over the past 30 quarters, S&P 500 companies have repurchased $2.8 trillion in stock.
That’s a lot of money that could have been put to better use. I’ve never been a fan of buybacks because companies routinely overpay. However, sometimes they actually make sense.
The second quarter’s largest buyback was made by Johnson & Johnson (NYSE:JNJ), which repurchased $12.9 billion of its stock, more than double Exxon Mobil (NYSE:XOM), which bought back $5 billion. J&J acquired 203.74 million shares at an average price of $63.08.
When evaluating share repurchases in a given quarter, I calculate the average of the stock’s high and low during the quarter, and if a company paid less than that, I consider it a reasonable effort. J&J’s average stock price during the quarter was $64.71, so it passes my test. But that’s not why its massive repurchase makes sense.
What makes J&J’s share repurchase so exceptional is that it was done to avoid paying tax on its overseas cash. Moody’s estimates J&J has $35 billion outside the U.S., the sixth-largest amount of any American company. When it originally announced its cash and stock deal to acquire Synthes in April 2011, J&J expected the transaction to cut earnings by 22 cents a share. Instead, it’s adding at least three cents to its 2012 earnings. That’s a pretty significant swing.
How did J&J accomplish this?
It got its Irish subsidiary Janssen Pharmaceuticals to fund the deal with cash on hand. The final purchase price for Synthes was $20.2 billion, based on the Swiss franc exchange rate on June 14, 2012, when the deal was completed and the closing price of J&J shares.
To complete the share portion of the deal, J&J entered two accelerated share repurchases with JPMorgan Chase (NYSE:JPM) and Goldman Sachs (NYSE:GS) in which the banks would borrow 203.74 million shares of J&J stock to hand over to Synthes shareholders. The banks will use Janssen’s cash to repurchase shares on the open market over the next year to repay the shares borrowed.
Under normal circumstances, Janssen would have to issue a taxable dividend to J&J in order to repatriate its Irish earnings. By structuring its share repurchase in this manner, the use of foreign cash is unlikely to be viewed as a taxable dividend. It’s a brilliant tax maneuver that illustrates how messed up America’s tax system is.
What does this mean for share repurchases?
I suppose it’s possible that more large companies will attempt the same maneuver in the near future. However, I doubt the IRS is going to take this sitting down. I’m not a tax expert, so I don’t know what the IRS can do to stop companies like J&J from practicing this type of tax avoidance, but it’s clearly a problem that, unfortunately, isn’t going to be resolved any time soon given it’s an election year.
So, for a large company with significant earnings overseas, my recommendation is to make a strategic acquisition outside the U.S. with that cash, utilizing the “J&J Plan” to avoid paying taxes. And you better do it soon because the opportunity won’t be around forever.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.
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