Share Repurchase:To Buy or Not to Buy

1. Introduction
§ Stock buybacks have leap-frogged corporate stock issues by ever-increasing amounts
§ Total number of shares repurchased in the last six years → far outstripped the total number of new shares issued
§ FEI members → Key findings:
i. 39% of the respondents instituted a share repurchase program → to improve their earnings per share numbers
ii. 28% → to distribute excess cash to shareholders
iii. 27% → their companies were trying to reduce the cost of employee stock option plans
iv. 12% → main reason → adjusting capital structure
§ Financial Executives Research Foundation → mission:
i. Determine the long-term effects of stock buyback programs on a company’s stock price
ii. Assess which companies benefit most from this programs
§ Data → 200 firms that announced, conducted and completed share purchase programs from 1991 to 1996
§ Completed Repurchase Plans → The firm announced and later purchase at least 50% of the shares authorized for the program
§ Firms that announced buyback program → usually just buy very little stock

2. Why Repurchase Shares?
§ Five commonly reasons:
i. To increase share price
ii. To rationalized the company capital structure
iii. To substitute share repurchases for cash dividend payouts → tax advantages
iv. To prevent dilution of earnings
v. To deploy excess cash flow → become alternative investment
§ Firm repurchases shares has different options:
i. Open market repurchases
ii. Tender offers
iii. Privately negotiated repurchases
§ Sample → Firms were consent in a range of industry and market capitalization:
i. 48% → have market caps below %200 million
ii. 10% → have market caps in excess of $10 billions
iii. 42% → along the continuum

3. Four Key Findings
§ Shares Outstanding
i. Proportion of share repurchases →5%
ii. This proportion → repurchases were measured in terms of numbers of shares or in terms of dollar value
§ No substitute for dividend payouts
i. Dividend payouts ratio → increase once the stock buyback program is over
ii. Large-cap and small-cap companies → reported the same increase in dividend payout ratios
§ Effect on earnings per share
i. The repurchasing firms → effectively closing gap → between their EPS growth rates and those of industry peers that aren’t buying back stock
§ Effect on debt
i. 27% of the fund used to finance the stock repurchases → stem from excess operational cash flow

4. Guidelines for Getting Going
§ A stock buyback program signaling:
i. Management won’t be funneling anymore money into markets or product lines that are dead ends
ii. The company isn’t hunting around for an acquisition
§ Companies repurchase equity only under these circumstances:
i. When they have excess debt capacity, and the supply of funds exceed the demand
ii. When they’re under-performing → profitability and sales growth rates→ relative to their industry’s averages
§ Companies should avoid stock buybacks under these circumstances:
i. When they’re over-leveraged and sales growth rates exceed industry averages
ii. When both their profitability and sales growth rates exceed industry average
§ A share repurchase program → must be conducted in strict accordance with federal securities laws to avoid liability for market manipulation or insider trading
§ Company’s board of directors → must determine that any purposed buyback program is a sound course of action and that it’s in the best interests of shareholders

5. The Value Connection
§ Shareholder Value Based Management → demonstrates that long-term shareholder value is created buy the firm’s growth and profitability prospects from its product market positions
§ The company’s decision to conduct a repurchase program could be misinterpreted by investors as a negative signal
§ But also can be a positive sign → because investors interpret the repurchases as the welcome return of capital and an indication that management is turning the business around
§ Conducting a successful stock buybacks → he or she must figure out how to bring the two major aspect – strategy and finance – together in the most effective way possible