Stock buybacks sometimes bite back
By Rachel Beck
Associated Press
NEW YORK — Investors who see company buybacks of their stock as only good news may be overlooking the serious damage that certain share repurchases can do to companies' financial health.
While many companies are paying for buybacks with cash they've accumulated since they aren't spending it on such things as hiring or capital investments, some also launch buybacks using borrowed money — a potentially risky move.
That's something investors must consider today amid the boom in buybacks, which are close to record highs.
Corporate executives often tout repurchases as a boon to investors. That is because they usually see at least a short-term stock bounce and buybacks leave fewer shares outstanding, giving each remaining shareholder a greater percentage of corporate ownership.
Buybacks for companies in the Standard & Poor's 500 stock index totaled nearly $46 billion in the third quarter, a 34 percent gain from a year ago and just trailing the record set in the first quarter of 2000. For the 12 months ended in September, there were $170 billion in buybacks, topping the previous record of $162 billion in the 12 months ended September 2000.
That surge has largely been fueled by the big gains in cash holdings on corporate balance sheets, with companies continuing to resist making significant purchasing decisions in these uncertain economic times.
Microsoft Corp. announced in July that it planned to purchase up to $30 billion in stock over the next four years to help reduce its $60 billion cash holdings. It also is issuing a $3 per share special dividend that is expected to eat up another $32 billion. Other cash-rich companies doing buybacks include Intel Corp., Wal-Mart Stores Inc., and Home Depot Inc., which bought back 7 percent of its stock over the last year, according to David Fried, who publishes The Buyback Letter, a financial newsletter tracking stock repurchases.
"For many companies, it is better to use the dollars to buy the stock than to do other things right now," said Fried, who also heads Fried Asset Management Inc. in Pacific Palisades, Calif.
Yet there are potential downsides, too. For instance, companies can use buybacks to mask a slowdown in earnings growth. By eliminating the number of shares outstanding, that can boost earnings per share even though company fundamentals haven't really improved.
Also troublesome is how companies finance their buybacks, especially those that borrow money to cover the costs.
Hospital operator HCA Inc., borrowed the full amount it needed for a $2.5 billion buyback last month, which spurred credit-rating agency Standard & Poor's to downgrade its debt rating.
The reason for the rating cut: The company saddled itself with lots of extra debt, but did not add any business to pay for the obligation. In addition, the Nashville, Tenn.-based company increased its leverage even as it has been struggling — a result of such things as slower patient volumes and ballooning numbers of uninsured patients, said S&P credit analyst David Peknay.
"This weakened the company's financial profile," Peknay said. "They committed all this debt, and now hope that future operations can service that debt adequately."
Similar concerns were echoed on the news of the debt-heavy buyback by retailer Limited Brands Inc., the parent of Victoria's Secret, Bath & Body Works and the Express store chains. S&P downgraded the credit rating on the company's bonds after it announced a $2 billion stock buyback, paid for with cash and $1 billion in new debt.
The risks of such a move were raised by Carol Levenson, director of research at Gimme Credit. She said in a recent note to clients that the "timing couldn't be worse as the company will be depleting its cash and taking on considerable debt as its apparel results continue to disappoint and the success of the holiday season is yet to be determined."
Of course, not every company that borrows money to pay for a buyback will run into trouble. And, as Fried notes, there even could be some financial benefit. For instance, when a company that pays a dividend repurchases stock, it ends up saving money on the dividend payment on the shares it buys back and gets a tax deduction on the interest of the money it borrows.
That's why investors have to closely inspect each buyback. Making assumptions could cost them big.
