In September 2011, Berkshire Hathaway (BRK.A)(BRK.B) issued the following press release:
“Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10% premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.
Berkshire plans to use cash on hand to fund repurchases, and repurchases will not be made if they would reduce Berkshire’s consolidated cash equivalent holdings below $20 billion. Financial strength and redundant liquidity will always be of paramount importance at Berkshire.
Berkshire may repurchase shares in open market purchases or through privately negotiated transactions, at management’s discretion. The repurchase program is expected to continue indefinitely and the amount of purchases will depend entirely upon the levels of cash available, the attractiveness of investment and business opportunities either at hand or on the horizon, and the degree of discount from management’s estimate of intrinsic value. The repurchase program does not obligate Berkshire to repurchase any dollar amount or number of Class A or Class B shares.”
As usual, Berkshire Hathaway has set a model that corporations around the globe should take a closer look at. I’d like to note a few things about Berkshire’s buyback program that stand out as particularly sound, as well as some other ideas that I believe should become common practice in corporate share repurchase programs:
1) Indicating the price, derived from a valuation metric that investors can readily calculate, at which buybacks would be considered: Berkshire’s board didn’t waste any time mincing words – they think that the underlying business is worth considerably more than a 10% premium to book value, and they will potentially repurchase shares in an undisclosed quantity if given the opportunity to do so below this level. In my mind, this is desirable because management must come out and quantify how they look at the business, and set numerical criteria upon which they will be active purchasers of common stock; importantly, this thwarts any attempt to indiscriminately repurchase shares when the economy, stock market and the core business are all going gangbusters (and priced as if this state of affairs will continue indefinitely).
2) Requiring management to disclose (and focus on) valuation metrics: This is similar to the first point, but also has more practical benefits for shareholders; while book value may act as a crude guide for a (very) conservative estimate of Berkshire’s intrinsic value, there are plenty of other companies that would reject that notion entirely (rightfully so). At those companies, we would be given the yardstick by which the management team assesses the intrinsic value of the equity – which will provide a good point of reference when considering the metrics that determine the CEO’s compensation (a particular favorite of mine are bonuses tied to earnings/net income growth, rather than per share metrics; not too surprisingly, these companies tend to be quite fond of issuing shares to employees, as well as engaging in equity-funded M&A).
If management decides that a multiple of trailing non-GAAP earnings were appropriate, so be it; invariably, this would require a clear discussion on how those metrics are calculated, and why that’s the appropriate way to think about the company’s underlying value. Management should be upfront in their evaluation of the business, and how they determine whether or not they’re doing a good job (beforehand – as Warren’s noted before, many are tempted to shoot the arrow of performance and then paint the bull’s-eye around wherever it lands).
3) Improving accountability while maintaining discretion: The beauty of this approach is that it keeps management honest; too many companies say the right things, yet time and again find themselves buying shares hand over fist in the boom, only to sit idly by as the stock craters from its previous heights (this rule applies to nearly every company I’ve looked at in the period from 2006-2011). This approach all but guarantees that management will not fall into this trap.
At the same time, this comes with complete discretion – nobody is required to repurchase a single share, even if the stock falls below the repurchase cap; if excess cash can be put to better use reinvesting back into the core business or acquiring a struggling competitor, fantastic. Of course, those business decisions will now be judged in the context of their most apparent opportunity cost – repurchasing shares at a price that management had previously indicated would be beneficial to shareholders. Decisions must be made with opportunity costs in mind; the appropriate incentives are the only way to guarantee that such thinking is top of mind.
4) Authorization for many years: Again, I think Berkshire has the right approach – with the rest of corporate America looking on from the wrong side of the playing field. Most companies play a game where they authorize the repurchase of a set number of shares over a certain time period, which comes with periodic reauthorizations and pointless press releases. A good example comes from AT&T (T), where CEO Randall Stephenson said the following at the company’s most recent reauthorization:
“This action allows us to continue returning cash to our shareholders through dividends and buybacks while maintaining a strong balance sheet and investing in the future of our business.”
This is typical of these releases: either a blanket (see pointless) statement about the importance of driving shareholder value (without any discussion of the price/value relationship at the current time) or, as we have with Mr. Stephenson, a complete disregard (or lack of mention) for the most fundamental rationale for share repurchases – the creation of per share intrinsic value. It’s like going out and buying a company for additional subscribers and saying the price isn’t important – “millions of additional wireless subscribers is a good thing, so we figured the price didn’t matter” (just imagine how investors would react to this); in this one-sided view of capital allocation, more subscribers and less shares are the goal, and the cost is not a consideration.
Companies need to clearly articulate their criteria for share repurchases, and stick with those criteria for long periods of time; this is a step in the right direction towards avoiding the value destruction that’s been repeatedly caused by poorly timed share repurchases at many companies (by the way, AT&T didn't buyback any shares from 2009-2011, with the stock in the mid-20's for much of that time; they've bought it in size as of late, with the common trading around $35-40, or about 50% higher).
Conclusion
Sadly, I don’t expect these changes to happen; executives have little incentive to tie their own hands (potentially holding them back from juicing short term EPS figures as needed), and directors likely have little/no interest (or incentive) to make a push for these improvements. As a shareholder in a few companies that have shown poor timing (over a period of many years) when it comes to buybacks, it’s an unfortunate situation to be in – with relatively few attractive alternatives, and no way to instigate change; at least I can take solace in knowing that the directors of my largest individual holding – Berkshire Hathaway - think about share repurchases a bit differently, and more intelligent, than most.
“Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10% premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.
Berkshire plans to use cash on hand to fund repurchases, and repurchases will not be made if they would reduce Berkshire’s consolidated cash equivalent holdings below $20 billion. Financial strength and redundant liquidity will always be of paramount importance at Berkshire.
Berkshire may repurchase shares in open market purchases or through privately negotiated transactions, at management’s discretion. The repurchase program is expected to continue indefinitely and the amount of purchases will depend entirely upon the levels of cash available, the attractiveness of investment and business opportunities either at hand or on the horizon, and the degree of discount from management’s estimate of intrinsic value. The repurchase program does not obligate Berkshire to repurchase any dollar amount or number of Class A or Class B shares.”
As usual, Berkshire Hathaway has set a model that corporations around the globe should take a closer look at. I’d like to note a few things about Berkshire’s buyback program that stand out as particularly sound, as well as some other ideas that I believe should become common practice in corporate share repurchase programs:
1) Indicating the price, derived from a valuation metric that investors can readily calculate, at which buybacks would be considered: Berkshire’s board didn’t waste any time mincing words – they think that the underlying business is worth considerably more than a 10% premium to book value, and they will potentially repurchase shares in an undisclosed quantity if given the opportunity to do so below this level. In my mind, this is desirable because management must come out and quantify how they look at the business, and set numerical criteria upon which they will be active purchasers of common stock; importantly, this thwarts any attempt to indiscriminately repurchase shares when the economy, stock market and the core business are all going gangbusters (and priced as if this state of affairs will continue indefinitely).
2) Requiring management to disclose (and focus on) valuation metrics: This is similar to the first point, but also has more practical benefits for shareholders; while book value may act as a crude guide for a (very) conservative estimate of Berkshire’s intrinsic value, there are plenty of other companies that would reject that notion entirely (rightfully so). At those companies, we would be given the yardstick by which the management team assesses the intrinsic value of the equity – which will provide a good point of reference when considering the metrics that determine the CEO’s compensation (a particular favorite of mine are bonuses tied to earnings/net income growth, rather than per share metrics; not too surprisingly, these companies tend to be quite fond of issuing shares to employees, as well as engaging in equity-funded M&A).
If management decides that a multiple of trailing non-GAAP earnings were appropriate, so be it; invariably, this would require a clear discussion on how those metrics are calculated, and why that’s the appropriate way to think about the company’s underlying value. Management should be upfront in their evaluation of the business, and how they determine whether or not they’re doing a good job (beforehand – as Warren’s noted before, many are tempted to shoot the arrow of performance and then paint the bull’s-eye around wherever it lands).
3) Improving accountability while maintaining discretion: The beauty of this approach is that it keeps management honest; too many companies say the right things, yet time and again find themselves buying shares hand over fist in the boom, only to sit idly by as the stock craters from its previous heights (this rule applies to nearly every company I’ve looked at in the period from 2006-2011). This approach all but guarantees that management will not fall into this trap.
At the same time, this comes with complete discretion – nobody is required to repurchase a single share, even if the stock falls below the repurchase cap; if excess cash can be put to better use reinvesting back into the core business or acquiring a struggling competitor, fantastic. Of course, those business decisions will now be judged in the context of their most apparent opportunity cost – repurchasing shares at a price that management had previously indicated would be beneficial to shareholders. Decisions must be made with opportunity costs in mind; the appropriate incentives are the only way to guarantee that such thinking is top of mind.
4) Authorization for many years: Again, I think Berkshire has the right approach – with the rest of corporate America looking on from the wrong side of the playing field. Most companies play a game where they authorize the repurchase of a set number of shares over a certain time period, which comes with periodic reauthorizations and pointless press releases. A good example comes from AT&T (T), where CEO Randall Stephenson said the following at the company’s most recent reauthorization:
“This action allows us to continue returning cash to our shareholders through dividends and buybacks while maintaining a strong balance sheet and investing in the future of our business.”
This is typical of these releases: either a blanket (see pointless) statement about the importance of driving shareholder value (without any discussion of the price/value relationship at the current time) or, as we have with Mr. Stephenson, a complete disregard (or lack of mention) for the most fundamental rationale for share repurchases – the creation of per share intrinsic value. It’s like going out and buying a company for additional subscribers and saying the price isn’t important – “millions of additional wireless subscribers is a good thing, so we figured the price didn’t matter” (just imagine how investors would react to this); in this one-sided view of capital allocation, more subscribers and less shares are the goal, and the cost is not a consideration.
Companies need to clearly articulate their criteria for share repurchases, and stick with those criteria for long periods of time; this is a step in the right direction towards avoiding the value destruction that’s been repeatedly caused by poorly timed share repurchases at many companies (by the way, AT&T didn't buyback any shares from 2009-2011, with the stock in the mid-20's for much of that time; they've bought it in size as of late, with the common trading around $35-40, or about 50% higher).
Conclusion
Sadly, I don’t expect these changes to happen; executives have little incentive to tie their own hands (potentially holding them back from juicing short term EPS figures as needed), and directors likely have little/no interest (or incentive) to make a push for these improvements. As a shareholder in a few companies that have shown poor timing (over a period of many years) when it comes to buybacks, it’s an unfortunate situation to be in – with relatively few attractive alternatives, and no way to instigate change; at least I can take solace in knowing that the directors of my largest individual holding – Berkshire Hathaway - think about share repurchases a bit differently, and more intelligent, than most.
