The extra investment performance created by share buy-backs has dwindled to “negligible” levels, with many companies destroying shareholder value by ill-judged share purchases, according to new research.
Share buy-backs have become increasingly popular in recent years as the expanding economy has strengthened corporate cash-flow and boards have bowed to perceived investor pressure to hand cash back. The relatively low level of debt carried by listed companies has also provided scope to take on more leverage and return cash through share buy-backs.
When a company pursues a share buy-back, it nominates a broker to buy its shares in the stock market. Normally these shares are then cancelled, so the company’s earnings are then distributed less widely, and this boosts earnings per share (EPS).
It is estimated that in 2007 almost 15 per cent of Europe’s large and mid-cap companies have undertaken buy-backs exceeding 2 per cent of their market capitalisation.
However, Collins Stewart, the broker, says many companies are ignoring the “essential valuation criteria” that determine whether or not a buy-back creates value for a company’s investors.
It says companies focus too much on boosting EPS, when the fundamental question should be the price at which shares are repurchased. It also blames investment banks for advising companies to do ill-judged buy-backs just for the fees.
“We find numerous examples where the rationale for a buy-back – usually involving EPS enhancement – ignores the basic principles that will best ensure positive returns to shareholders,” says Collins Stewart. “A substantial number of buy-backs are, collectively, destroying billions in shareholder value through ill-judged decisions.”
The research found that in aggregate, there was less than a 50 per cent chance that a share buy-back would now lead to a company’s share price outperforming.
The general problem, Collins Stewart argues, is that shares are less cheap than they used to be. However, the broker singles out several UK companies for particular criticism, including Next, Tate & Lyle and LogicaCMG.
Tate & Lyle, Europe’s largest sugar refiner, conducted a buy-back in August after issuing two profit warnings and ignoring “the near-inevitability of a third”, says the study. When a third profit warning happened, it knocked the share price and generated a paper loss of £10m on the shares Tate had bought back.
LogicaCMG, the information technology services group, similarly bought back shares after its May profit warning, but in November issued downbeat guidance following the appointment of a new chief executive, further depressing the shares and creating a paper loss of £26m.
Meanwhile, Next, the retailer dubbed by Collins Stewart as the “buy-back junkies par excellence”, destroyed a notional £70m of value on its buy-back this year – in spite of a good record in previous years.
Tate & Lyle says its buy-back was launched with the support of its shareholders.
“They welcomed it because it made efficient use of our balance sheet after our sale of European starch assets. Less than 20 per cent of the buy-back had been completed when the share price fell in the autumn. Since our results announcement in October, we have resumed the buy-back with the full support of our shareholders,” he says.
Next is also unapologetic. The retailer says: “Next has a stated policy, the board firmly believes that it is by improving EPS over a period of time that drives the share price and shareholder value. Next does have quite a lot of rules about the circumstances for buying back shares.”
LogicaCMG declined to comment.
Collins Stewart says an emphasis on EPS-based performance hurdles in executive bonuses could create an incentive for boards to sanction share buy-backs even when their share price is too high.
It blames guidance from the Association of British Insurers, dating back to 1990, that share buy-backs are to be exercised only “if to do so would result in an increase in earnings per share and is in the best interests of shareholders generally”.
The study says the ABI’s guidance is “like a red rag to a bull for managements who may find it, perhaps coincidentally, to be closely aligned with their own interests”.
However, Peter Montagnon, head of investment affairs at the ABI, rejects the accusation and says Collins Stewart is jumping to conclusions that are not justified, especially given that the ABI guidance stresses that buy-backs should always be in shareholders’ interest.
“It is simply wrong to say we are encouraging buy-backs and falling into the trap of encouraging executives to use them to meet their performance hurdles,” he says.
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