The move by Rupert Murdoch’s News Corporation to spend some $5bn on share buybacks following its reluctant decision to shelve plans for full control of satellite broadcaster BSkyB reflects much more than the global media giant’s retreat over the phone hacking scandal.
It underlines a wider trend among companies to invest surplus cash in share buyback schemes as an alternative to takeover bids and other corporate expansion plans. Murdoch was backed into a corner over BSkyB and took the pragmatic and tactical investment alternative in the face of News Corp’s crumbling share price.
No such dramatic imperatives have driven the dozens of other major corporations, including global pharmaceutical giants like GSK and AstraZeneca and chemical groups Celanese, DuPont and Ashland, which have recently announced or accelerated share buyback plans. In the US stock market alone this year there have been 26 accelerated share repurchases totalling around $8.5bn, according to a survey by Citigroup.
Behind these decisions, not all of which have been taken to divert funds accumulated for potential takeover targets, is often one or more of the following reasons: low interest rates, a dearth of attractive takeover opportunities, market uncertainty and a desire by companies to boost their own share price. With general interest rates in the EU and the US at historically low levels, there is no incentive for companies to maintain cash balances significantly above levels required to satisfy corporate liquidity rules.
Given the relatively weak state of the economy in the US and many parts of Europe, plus little realistic hope of a short-term surge in economic growth rates, this situation is unlikely to change markedly in the foreseeable future.
Although there may be money burning a hole in the pockets of many traditionally acquisitive big corporations, there is a distinct lack of suitable takeover targets, particularly in the global pharmaceutical and petrochemical sectors. This is due partly to the fact that these sectors have relatively recently experienced a virtual tidal wave of consolidation and rationalisation. This upheaval has seen many of the juicier takeover targets swallowed up or priced beyond levels that can easily be justified by all but sovereign equity funds where strategic expansion motives may outweigh strict value judgments.
Where consolidations and takeovers completed in the post-2008/9 economic downturn are still being absorbed, there is still the potential for unwanted businesses to come back onto the market. But many will be too small or occupy too narrow a niche to be of significant interest to the likes of traditionally expansionist majors in the pharma and chemical segments.
Another, and equally compelling, disincentive to the earmarking of surplus cash for takeovers is the febrile state of the global financial sectors, especially in Europe and the US where well-publicised national debt crises continue to cast a shadow over both bond and equity markets. Of course, market volatility can throw up new investment opportunities but more often than not it simply reinforces a more cautious and predictable strategy, and one that can be promoted – at least superficially – as returning cash to shareholders.
This was the justification used by GSK in February 2011 when it promised to purchase up to £2bn of its own shares during 2011. The UK-based pharmaceutical group also raised its full-year dividend despite annual pre-tax profits plunging by 62% or just over £4.7bn to £3.15bn on turnover flat at £28.4bn. Chief executive Andrew Witty explained in announcing 2010 full year results that GSK’s business model has been ‘substantially re-engineered over the last two-and-a-half years, through major restructuring and a rigorous returns-based approach to capital allocation’. He stressed the company would continue to seek smaller acquisitions as long as the valuations were acceptable, but said he had been able to generate sufficient cash to return a surplus to investors.
The effect of the buyback and dividend increase on GSK’s stock price was as swift as it was dramatic. Shares in the world’s third largest pharmaceutical group, which had fallen almost 20% in the previous five years, jumped 40p to £11.68 as investors welcomed confirmation that the buyback was to resume. Although other factors have since come into play, the post share buyback announcement surge in GSK’s stock has continued. By the middle of July, its shares were trading at £13.30 and close to 12-month highs.
Anglo-Swedish drugs group AstraZeneca’s pledge earlier this year to double its share repurchase programme to $4bn from $2.1bn in 2010, also had a rejuvenating impact on its stock market value. It has climbed from around £28 a share at the time of the buyback announcement to around £30.77 by the middle of July.
The announcement by Celanese of a $200m increase in its share repurchase programme plus a 20% rise in divided payments was given a predictably warm welcome by shareholders. The Swiss chemicals group had some $70m left of an earlier $500m share buyback programme when it made the repurchase announcement in April 2011.
In the same month, American chemical giant DuPont announced plans to spend up to $2bn on repurchasing its common stock. It said the repurchase scheme was aimed at offsetting dilution resulting from shares issued under compensation plans. DuPont adds that the new repurchase programme would only begin when it had completed share purchases under a buyback scheme announced in 2001. When it announced the $2bn plan, there was about $500m left under this earlier programme.
DuPont’s decision was made about six weeks after directors of US specialty chemicals company Ashland announced a $400m stock repurchase programme and declared a 10 cents/ share increase to 70 cents in annual dividend. ‘The implementation of this stock repurchase programme reflects our view that the market has not yet fully recognised the value of Ashland today,’ said James O’Brien, Ashland’s chairman and chief executive. ‘This programme and the contemplated dividend increase enable us to continue rewarding shareholders in a variety of ways, while retaining the financial flexibility to support our existing growth plans.’
UK specialty chemicals company Croda, meanwhile, rather hedged its bets when it announced in February plans to invest £50m in share buybacks this year. It qualified the initiative by adding that the money would be spent on share repurchases if excess cash wasn’t invested on an acquisition. Croda’s plans for its surplus cash were announced together with strong rise in annual pretax profits and an increase in dividend payments – news that sent Croda shares up by around 7% to just over £16.
This trend has continued and by the middle of July 2011 the company’s stock was trading at around £19.80, further underlining investor confidence in the management’s ability to protect profit margins by pushing through product price rises. Croda was unable to say how much, if any, of the £50m earmarked for share buybacks had been spent on stock repurchases.
However, the general appreciation during 2011 chemical and pharmaceutical company stock prices is likely to further fuel the argument that buybacks don’t always represent good value to shareholders. It is generally true that shareholders usually welcome share buybacks, dividend increases and the return of cash. Their reaction, though, is often dependent on how their income is taxed and whether there is any major disparity between the policy on capital gains versus dividends.
The practice of share buybacks also has its critics among financial analysts. Terry Smith, chief executive of interdealer stockbroker Tullett Prebon and analyst at Fundsmith, has been a particularly vocal opponent of share buybacks, which in his estimation fail to create value. He has argued that share buybacks only create value if the shares repurchased are trading below intrinsic value and there is no better use for the cash that would generate a higher return. Indeed, he asserted that most buyback programmes undermine value for remaining shareholders, arguing that company management is able to conceal the true effect due to a loophole in accountancy rules.
Smith explained that when a company repurchases shares they disappear from the balance sheet, ‘and this can be used to distort measures of company performance’. He added that by executing a share buyback rather than paying out dividends, companies can inflate their earnings per share (EPS) and are almost universally seen to have created value for shareholders when mostly they clearly have not.
Smith said management should be required to justify share buybacks by reference to the price paid and the implied return as well as comparing this with alternative uses for the cash. He added that accounting for share buybacks should be changed so that the shares remain a part of shareholders funds as well as an equity accounted asset on the balance sheet in calculating returns.
Finally, and perhaps most controversially, Smith said share buybacks should be viewed with more than average scepticism when executed by companies whose management are incentivised by growth in EPS. Not surprisingly, companies contacted by C&I over their share buyback policies have defended them vigorously as in the best interests of both individual shareholders and the overall corporation.
Neil Sinclair is a freelance writer based in London, UK.