Cash Flow

End of the Line for Share Buybacks? Don’t Count on It

Buybacks are sure to remain on the European investment scene, not least because so many companies are sitting on very significant cash balances gen...
Andrew SawersApril 11, 2012

Investors like them — but sometimes they don’t. Companies still use them, but at least one group of academics sees major flaws. But they appear to create value.

Share buybacks may be a headline-grabbing way to return surplus cash to investors. They’re also a way of making a high-profile statement about your share price. But if you get it wrong, the shareholders who don’t sell can be very annoyed if it looks like you’ve paid over-the-odds for something that has slumped in value: their own shares.

Now a group of economists, funded by the European Commission, says there ought to be much more stringent corporate-governance regulation around share buybacks — or that they should even be banned altogether. In February, Finnov, a three-year research collaboration among seven universities and other institutions from the United Kingdom, Italy, France, and the Czech Republic, called for “radical and immediate reform of the financial system.”

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Such a reform would include a recommendation that share buybacks be subject to “stronger governance or banned outright.” Finnov said that share buybacks are “a manipulation of the market, boosting companies’ share prices (and executives’ options and other ‘performance pay’) at the expense of R&D.”

The report has been almost totally ignored by the press. But if the language sounds strident, consider that a Financial Times columnist recently argued that Anglo-Swedish pharmaceutical group AstraZeneca has been trying “to keep investors sweet” by cutting jobs, paying a generous dividend yielding (above 6%), and promising big share buybacks.

In a statement, AstraZeneca told CFO European Briefing, a CFO online newsletter, that its “share repurchase programme provides a flexible means of returning value to shareholders and allows the company to manage its capital structure efficiently.

“It’s also worth noting that, in terms of returns to shareholders, we have a generous yield on our shares already and we have a stated policy of maintaining or growing the dividend every year. Any buyback obviously comes on top of that return. In setting our distribution strategy, we aim to strike a balance between the interests of the business, our financial creditors, and our shareholders.

“After providing for business investment, funding the progressive dividend policy and meeting our debt service obligations, the Board keeps under review the opportunity to return cash in excess of these requirements to shareholders through periodic share repurchases.”

Taken at face value, it would seem to be the right strategy. According to research produced in March by Deutsche Bank, share buybacks can actually add value. Analysts with the firm calculate that the shares of companies that execute buybacks produce excess returns over the 60 trading days after a buyback announcement of between 1.59% and 2.42% relative to MSCI World indices (equal weighted and market cap–weighted, respectively).

Longer term, over the three years following buyback announcements, the excess returns are even greater: 11.97% and 25.18% (relative to the same benchmarks). Note, however, that, over the longer term, the results were least positive for European companies compared with those in North America, Japan, and the rest of Asia.

The Finnov report argues that, even if one accepts the “highly contentious arguments” that buybacks create value for shareholders, “it is not clear why these extra distributions should not take the form of dividends, which reward stable shareholding, rather than buybacks, which reward shareholders who buy and sell.”

In truth, buybacks aren’t always popular with investors. At Legal & General Investment Management, the preference is always for dividends. David Shaw, a portfolio manager with the European active equity team, says companies tend to keep their dividend flat or to increase it, whereas with buybacks “they tend to be a short-term distribution of one-off profits. Buybacks are great — they’re better than them hoarding the cash — but much preferred would be dividends as a confident sign of showing stable, growing earnings.”

Shaw adds that buybacks are sometimes deployed to buy in stock to counter the number of shares issued for senior executive incentive schemes that would otherwise dilute the existing shareholders. But he points to two flaws in the way buybacks are sometimes used. “We’ve noticed with some buybacks that they get announced and never completed,” he says, so the company won’t actually buy back all the shares it said it would.

The other issue is that companies often buy back their shares on the market but then hold those shares as so-called treasury stock on their balance sheet rather than cancelling them. Not only does this mean that there is no benefit to earnings per share (because the full number of shares must be taken into the calculation) but it means the company can simply sell those shares back onto the market again. That doesn’t go down well with investors.

The arguments about the merits of buybacks seem set to continue. Shaw admits that companies receive “mixed messages” from the different institutional investors they meet: “Different people focus on different things.” Either way, buybacks themselves are sure to remain on the investment scene, not least because so many companies across Europe are sitting on very significant cash balances generating very low yields.

Andrew Sawers is editor of CFO European Briefing, a CFO online publication.