Capital Markets

Equity: Buyback Fever

Now that the stock market is selling off again, CFOs are back in buyback mode.
Kris FrieswickNovember 24, 2000

When the market was at its peak last year, buybacks were the last thing on CFOs’ minds. But now that the market is a little less enthusiastic, CFOs are back in buyback mode.

Companies launching or boosting stock repurchase programs in the past three quarters include giants such as Exxon Mobil, BP Amoco, Ford, and Hewlett- Packard, as well as smaller companies such as Quantum Corp., which has repurchased almost 12 percent of itself in the past four quarters. {Editor’s note: Since this story went to press, at least two large companies have announced buybacks–Hewlett-Packard and PepsiCo.}

“For midsize companies, it’s about asking yourself how many opportunities do you have to invest in things that will drive revenue and earnings growth,” says Richard Clemmer, CFO of the $4.7 billion computer storage supplier. “If you’re investing at the level required, a buyback is the best way to return value to the shareholders. Especially if your company is trading below book value.”

Companies usually offer at least one of five basic reasons for a buyback: to boost stock price, to rationalize the company’s capital structure, to substitute cash dividends for repurchases, to prevent dilution from stock op-tions grants, or to give excess cash back to stockholders, according to a recent study of buybacks between January 1, 1991, and December 31, 1996.

However, the study, conducted by San Diego State University professors S.G. Badrinath and N. Varaiyat for the Financial Executives Research Foundation, shows that the results of buybacks often belie the stated rationale. For instance, one of the biggest surprises, says Badrinath, was that companies do not substitute repurchases for dividends as a way to give cash back to stockholders. Of the companies studied, dividend payout ratios actually increased after share repurchases were complete.

The study also revealed another fly in the buyback ointment. The study shows that while earnings-per-share does rise substantially after buybacks, the EPS of nonrepurchasing firms in the same industry rises even faster during the same period. The buyback merely serves to close the EPS growth-rate gap.

On the bright side, the stock price of repurchasing firms rises at the same rate as industry averages in the three years following a buyback, but rises substantially slower before a repurchase.