M&A

Buyer’s Remorse

Share buybacks are expected to be less bountiful in 2008.
Jason KaraianMarch 3, 2008

Last summer, Austrian property developer Meinl European Land unveiled a plan to buy back 10% of its shares. Anticipating robust growth, repurchasing its shares at around €20 each was “very attractive,” according to a company statement. The buyback programme would “send a clear signal to investors regarding the company’s enormous growth potential.”

It sent a signal alright, but hardly the one that the company had in mind. Meinl’s directors were so bullish that they spent €1.8 billion buying back nearly 30% of the company’s shares. Fearing an overstretched balance sheet, investors panicked and a spate of ratings downgrades followed. Today, Meinl is trading at around €8 per share.

At a January conference in London, John Hatton, a managing director at Fitch Ratings, cited Meinl as a poster child for the rise in “event risk” downgrades in recent years. Because many companies used buybacks to fight off advances from buyout firms, the subsequent “self-inflicted” downgrades accounted for around 20% of ratings cuts in 2006 and 2007, up from single-digit percentages in earlier years. In 2008, curtailing buybacks will be an important “release valve” for companies facing slower earnings growth and tighter credit conditions, Hatton says.

But weaning shareholders off the massive payouts they once enjoyed is proving difficult. Last month, Unilever, Rolls-Royce and Cadbury Schweppes all saw their shares fall sharply after rebuffing calls for increased buybacks this year.

Despite the market’s reaction, new research from Morgan Stanley bolsters the companies’ case. Last year, the analysts identified a basket of UK companies with low fixed charge cover — Ebit divided by net interest payments — that resulted from aggressive buybacks. These shares have underperformed the market by 10%, on average, over the past 12 months.

Jérôme Laurre, a managing director at Barclays Capital in London, thinks that it’s “sensible” for CFOs to rein in buybacks given current credit conditions. That said, his firm launched a new product last year for companies that still have room for repurchases. Originally developed for AstraZeneca, the facility allows firms to authorise Barclays to execute buybacks within a certain timeframe, for a pre-agreed amount, at a discount to the volume-weighted average share price over the term and with no commission fees. Companies thus avoid daily calls to brokers and trading restrictions around results announcements.

While an appealing offer, given recent history how many CFOs will opt for short-term gain at the risk of potential long-term pain?