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William J. DeRosa, Jr., CFA
William J. DeRosa, Jr., CFA

Accelerated Share Buybacks

November 30, 2010 | About:

There has been a great deal of studies done over the years focusing on share repurchases. An article in Financial Analyst Journal covers this topic. Share buybacks have been a popular tool of companies whose share price are depressed, yet have significant cash flow or high levels of unrestricted cash on the balance sheet. Personally, I am not a big fan a buybacks as they often don’t necessarily create shareholder wealth.

Reasoning behind share buybacks includes the following;

  1. Undervalued shares
  2. Earnings management
  3. Avoiding share dilution due to stock option issuance
  4. Takeover deterrence
  5. Redistribution of cash
Unfortunately, many of the reasons listed above rarely are to the benefit of current shareholders. Please don’t misinterpret my point; a buyback used correctly can be a very efficient method distributing cash in a tax efficient manner. However, when a buyback is used to simply enhance earnings or deter takeovers often shares are purchased at expensive levels – which is basically throwing money away.

Recently it has become more common for companies to engage in accelerated buybacks. Typically, once capital has been authorized for share repurchase, it may take many months to fulfill the commitment. This also doesn’t guarantee that the full amount will be repurchased. In an accelerated buyback the shares are borrowed from an intermediary (investment bank) and delivered to the company immediately which eliminates the buyback. The bank then proceeds to purchase the shares on the open market over the course of many months. Of course, the aforementioned investment house is happy to perform this duty for a nice fee. Many investors will ask – does this activity help the stock price? Frankly, the evidence is inconclusive. However, the more important question is – does this activity actually create shareholder value? With the additional fees required, it is a very difficult hurdle to overcome. Unless, the shares have become vastly undervalued (i.e. the market bottom in 2009), the cost isn’t worth the reward.

Recently a number of companies have embarked on accelerated buybacks – Home Depot, Hewlett Packard, and Dollar Tree to name a few. It will be very interesting to review this decisions in the future to determine if shareholders actually benefitted.

About the author:

William J. DeRosa, Jr., CFA
William J. DeRosa, Jr. is the General Partner of Anthem Asset Management, LLC is an independent investment management company. He has also served as Director of Equity Research and Senior Portfolio Manager at various buy-side asset management firms. Mr. DeRosa is a Chartered Financial Analyst and is a member of The CFA Institute.

Rating: 3.8/5 (4 votes)


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