Share buybacks? Harbingers of doom, or a win-win? Or an opportunity for the ACCC? Bud Buyback reports on this growing trend.

IAG stands out for one. It is right upfront and has recently mailed out a current prospectus to shareholders that gives the reason for the share buyback, which is a more efficient capital structure, replacing shares with newly issued ‘reset preference shares’ and hopefully leading to increased earnings per share. Seriously, well done IAG.

Elsewhere, things are more opaque and confusing.

Possibly the spate of share buybacks springs from an effort to benefit the community. As ANZ boss McFarlane said in a Business Sunday interview on 14 April this year “Look we’ve all agreed that we spend hours and hours as a group (of banks that is) agreeing that we have to invest in the community, that each one is responsible for our actions such that we do not knowingly do harm to the others (banks) and to the community as a whole, that is an agreement that we (the banks) have and we (the banks) regard that as binding.”

Comforting indeed. That clears up one line of inquiry that is even endorsed by Prof Fels and the ACCC no less.

Sometimes, the reason given for a share buy back is “capital management”. For example, here’s what NAB’s Chief Financial Officer, Richard McKinnon said in a press release on 9 May 2002.

“The additional buy-back is an efficient and flexible means of continuing to maximise shareholder return and maintains our commitment to active capital management,” said Chief Financial Officer, Richard McKinnon.

“Extending the buy-back is sensible capital management as our capital ratios are at present above the high end of target ranges,” he said.

Possibly, but.

Share buybacks seemingly have nothing much to do with capital management unless offset by some other form of security, like in IAG’s situation. What is the company going to do? Reissue them later? May be it is more an admission by the directors and management of a company that it does not presently have a growth strategy or alternatively, if it does, it has discovered a magic pudding that does not require increased capital investment for sustained growth. That really is some company and maybe NAB and McKinnon have really discovered something here for the new millenium. On the other hand, maybe the answer is sustained growth through sustained cost cutting. The new company which eventually has no costs? Now that really would be organic growth.

Maximise shareholder returns? In simple terms, the sum of the annual share price increase and the ongoing dividend yield must exceed the company’s return on capital. It assumes the company’s share price will increase nicely and annually, never mind not falling when the on-market price support is removed after the buyback finishes. Both propositions are open to question when in the case of a bank or insurance company (IAG’s situation is excepted), the life blood is capital.

Return of capital, a valid description? Triple bollocks. Basically what is happening when a company that engages in a massive buyback of its own shares is that a chunk of the company is going into a new business. That business is a non-diversified investment company that invests solely in one company – itself. A return of capital is nothing of the sort. That would effectively involve a special dividend to all shareholders, not a selective buyout of the interests of some shareholders by the other shareholders.

Why then are on-market share buybacks sometimes described as a return of capital when they are obviously nothing of the sort? And do the retail shareholders, the mums and dads, understand? Is this the binding community spirit that will do nobody harm? Maybe everything is really just fine, but maybe the ACCC, or even ASIC, should take a look at this one just to make sure, just in case. One can’t be too careful where representations involving OPM (other peoples’ money) is involved. Mr Fels and Mr Knott, where are you?

Who wins then? Instos may get a nice stable share price, at least for a short time. Maybe they can even lighten up their holding in the company’s shares without precipitating a share price fall? Management’s bag of options may even prop into the money long enough to exercise? The board and management may get a bit of a breather from market pressure whilst they figure out what on earth to do? And there is always the option to extend if more thinking time is required, in the interests of all shareholders of course. Maybe it all does work out for the best in the long run and the boards and managements will prove to have performed magnificently for all the owners of the company. The classic win-win. If nothing else, it keeps them all guessing.

What is the historical long term ‘win-win’ success rate of a share buy back operation?

Not much good asking the analysts if the recent revelations of their cosy relationships with the companies they report on is anything to go on.

And maybe not much good asking the various companies involved either. They may have never tried it before and don’t know the answer, and for the companies where it didn’t work out, well, they might not be around to ask.

Maybe Crikey readers can suggest contributions to an historical list of winners and losers of yore from sustained share price support schemes, sorry ‘returns of capital’, sorry, ‘share buybacks’, sorry, ‘capital management’.

Peter Fray

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