Who gets the money spent on share buybacks?
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Sure, if you believe your stock is overvalued raise cash and retire debt, and if you believe it's undervalued take on debt and buy back shares. That's orthogonal to the issue of "if I want to give back 100$ to my shareholders what's the best way to go about it?".
Since management both holds lots of options and makes the decision to do buybacks it is unlikely that they are completely unrelated. Empirically it has been know since at least 1998 that management with lots of stock options are more likely to buyback shares[1].
yep, sounds like a nice reason for otherwise completely stupid action - willfully spending best asset, cash, [thus in particular worsening the company's asset structure] to buy the worst asset - the company's own stock - as the stock once bought back loses all the value to the company.
Those two things are not connected in any way. Say you do a share buyback of 100 shares and give out 50 shares in compensation to employees. What you've done is given 100Xshare_price to your shareholders (you've gone out on the market and bought those shares from them) and 50Xshare_price to your employees (by issuing the new shares and thus diluting your shareholders). That second decision is independent from the first.
Dividends theoretically should cause a fall in share prices the day after. Most aren't nearly large enough to be noticeable but for example in 2004 Microsoft issued a $3 dollar dividend and the share price fell by roughly that amount.
Conversely, stock repurchases you have money out but you also have a concentration of the stock.
In both cases money goes out of the company reducing its NPV but with stock repurchases the concentration and corresponding increase in EPS should offset the loss of money assuming the stock is priced correctly.
So there is an incentive for anyone with options to not pay dividends and save that money for stock repurchases. As well although theoretically buybacks shouldn't increase prices they do tend to as its seen as sign that management thinks the price is undervalued.
Both cases have the same exact outcome. If the company is worth Y and you decide to give out X, at the end of the transaction (dividend or repurchase) the shareholders as a whole will have a company worth Y-X on their hands plus X in cash for the same total of Y.
> As well although theoretically buybacks shouldn't increase prices they do tend to as its seen as sign that management thinks the price is undervalued.
That is indeed an extra benefit of repurchases, that they potentially signal that management believes the share is undervalued.
Think of it this way. Consider a company has NPV of 10 dollars with 10 outstanding shares priced at $1 and 5 dollars in the bank. If it pays out 5 dollars in dividends the NPV is now $5 and there are still 10 outstanding shares worth 50 cents each.
If the same company buys stock back with that 5 dollars the NPV also falls to $5. However there are only 5 outstanding shares now so each share is still worth 1 dollar.
Now if management doesn't have options, story over no one is any better or worse off assuming market efficiency.
However if management has options to buy 5 shares at say, 25 cents, they gain significantly more because the total number of shares has been diluted but the NPV is still the same.
In the first scenario total shares increase to 15 and their value decreases to ~33 cents. Transferring 1.6 dollars to management.
In the second scenario total shares increases to 10 and their value decreases to 50 cents. Transferring 2.5 dollars to management.
Yeah, that has been discussed in a few other comments. There's nothing stopping you from doing the same deal with dividends by giving out the dividend as well as adjusting the outstanding options, or adding clauses to the options to fix this case by changing the strike price or number of options in case of share buybacks.
The article doesn't argue that though, it's saying that since not all shares are retired and some are used as compensation that the value of the buyback isn't all given to shareholders. In reality those two transactions (buyback and issuing shares as compensation) are completely separate transactions that don't depend on each other.
Also I think I am wrong. Stock options are public information so it should be incorporated into the price of the stock any ways. Theoretically at least.
Say you take control of a company with a nice cash pile from past successes, but that isn't doing too great. You manage to get a great deal of options on the expectation you'll invest that cash pile to grow the business.
Now you can work your ass off to grow the company, or if manage to convince the right people so you can get those buybacks through, you could go for burning through that cash pile on buybacks, and profit nicely from the resulting rise in share price.
And if you're really good at sweet-talking the board, you could manage to sneak in additional options too. After all the share price is rising.
It's mostly a "buyer beware" type thing: It's not good or bad per se. Often the employee stock compensation may be necessary, e.g. to lure fresh blood in. And sometimes buybacks is the best response to a stagnating business: There may not be a short term prospect to be able to invest that cash pile in new product lines, for example.
But it's bad for you if you invest without understanding what is going on. Then again, that's always the case.
That won't work actually. In an efficient market the share price is unchanged by a share buyback. What will change is earnings per share, as you have the same earnings divided by less shares.
> But it's bad for you if you invest without understanding what is going on. Then again, that's always the case.
If you can get a deal where raising EPS gets you a nice bonus, then sure you can game the system. Those shareholders don't know what they're doing. The shareholders are still the ones that are getting the money from the share buybacks they're just also deciding to give a bonus to management based on flawed metrics.
1st read the 2013 IBM annual report's financial section as it relates to this subject. A cursory read will tell you that the following quote is completely false:
"There are two ways of looking at this. The first is that IBM spent $13.859 billion buying back those 73 million shares — an average of $190 per share. But in fact the share count only fell by 50 million shares, which means that IBM actually paid $277 per share by which the share count was reduced. That’s a crazy sum of money, far greater than IBM’s all-time-high share price. (The current price, by the way, is $162.)
The other way of looking at this is that the $13.859 billion didn’t really go entirely to shareholders, as Sorkin implies. Rather, some 50/73 of it went to shareholders — that’s about $9.5 billion — while the rest of it, about $4.4 billion, went, in one way or another, to employees. And especially to senior employees."
Without boring everyone to tears the author makes the completely false assumption that new shares issued are issued at $0 (however employees exercised 5.6m shares at $90 a share, or say the 1.5m shares employees purchased at a 5% discount to market price, there are a whole host of other programs)
A long time ago a company (I think it was GM, but I'm not sure) got clever. Instead of declaring a dividend, they did something like an 11 for 10 stock split, then did a buyback of 1/11th of the outstanding shares.
The net result is that each shareholder ends up with same number of shares that they had before, and the same fraction of ownership of the company they had before, and they received money from the company in proportion to their share of ownership. It's just like a dividend--except it could be reported as a stock buyback and get treated as capital gains instead of ordinary income.
Because of this, what was once was a short paragraph in the Tax Code is now a couple pages or so, in order to close that loophole without taking capital gains treatment away from legitimate buybacks.
When you gaze at the ~3000 pages of the Tax Code (the widely reported 70k pages is a gross exaggeration) and wonder how it got so big, a good part if of it is because of things like that split/buyback trick. People will put a lot of effort into finding ways to minimize their taxes (rightly so), and so a lot of things have to be specified in great, nit-picky detail, such as how to decide if a buyback is really a buyback or is some kind of disguised dividend or other payment.
Why tax them differently? In Canada, share buybacks create "deemed dividends" to ensure equal treatment.
Whether a buyback decrements the number of shares or reduces the number of contractually-obligated shares issued is irrelevant to me as an investor; the number of shares at the end of the buyback process will be smaller than if it hadn't happened.
How does that work, exactly? Tone: Honest question. I don't understand how a company could create new stock for itself, since it seems like that would therefore dilute all current shares and thus being almost by definition against the interest of all current stock holders and therefore something they would not permit. (I say this not to argue it is therefore impossible, but to highlight what misperceptions I may have that need correction.)
Now back to the stock incentives programs. Here you are issuing stock and giving it to your employees. Assume you had to give then X$ in cash as compensation, you could just do the same as before, raise that money in the market and give the cash to them. You might as well do it in one step giving them that value in stock and get the added benefit that those employees are now financially invested in the outcome of the company.
Buybacks (and dividends) are indeed neutral to shareholders. You have a company that's worth Y and you buyback X$ using company cash, the shareholders now have in their hands a company that's worth Y-X and X$ in cash, for a total of Y.
If, however, you believe that the market is 100% efficient and the price is always just right, then both of these actions will be neutral to shareholders.
The market is saying one thing. You believe another. So you bet against the market and the end result is... no change that affects shareholders?
If that were true, why would a corporation do this?
At the moment of the transaction there's no change, you've just swapped money for stock and could swap it back the moment after and be back to square one. If you are right and the market is wrong you'll make money on the transaction in the long run. It's just like buying stock for your own account. The moment you buy your net worth doesn't change you've just changed your asset mix between stocks and cash and could change it back with a sell order. Only by the stock changing value over time do you gain or lose net worth.
PS: Starting your comments with "No." doesn't really add much to the discussion.
While it does not affect the line item "shareholder's equity" it very much does affect individual shareholders.
It is not a magic wash covered by some "perfect market" force and shareholders will very much complain about dilution. This was OP's question and you've repeatedly talked in circles around it.
Think of the simple case - a company with $100 cash, and 100 shares, with a value of $1/share.
You buy 75 shares for $75. You now have 25 shares outstanding, and $25 cash. Still, $1/share.
Alternatively, you can issue 100 shares @ $1/each. You now have $200 cash, and 200 shares outstanding.
Share Buybacks/Share Issues (not including tax consequences), are neutral transactions.
Shady Patents, Inc has 10 shares outstanding. Current price is $1/share. I own one share.
They issue 90 more shares at $1/share.
Yes, duh, shareholder's equity remains constant. Shareholder DILUTION however is substantial. If they collect $1 million on a patent and issue a special dividend, I'm getting $1,000 instead of $100,000.
YES, there's an equal credit and debit on the balance sheet. NO, this does not mean the market will prop up the price. OF COURSE issuing shares is going to create downward share price pressure. If it didn't, companies would just issue shares indefinitely. And yes, to back up what poor OP said six hours ago, shareholders often resist dilution.
Clearly that payout was not priced into the original share price a the time of the capital raise so the new shareholders indeed got a great benefit at the expense of the old ones. At the moment of the transaction though the company went from being valued at 10$ to being valued at 100$ and for that to happen 90$ in cash was added to the company. The company could have turned around and used the same 90$ to buy back the same shares, which is why the transaction itself is neutral to shareholders. As the share price changes over time that may turn out to be a good or a bad idea.
I never said market cap equals cash on hand, I'm talking about the normal valuation of the company. You have a company that is valued as a whole at 10$ by the market, not just cash, everything. You raise 90$ of capital by issuing 90 new shares, bringing the total up to 100 shares. That company is now worth the original 10$ plus the new 90$ that were put in. So it's worth 100$ in total and still 1$ per share. This is just the basic math of a capital raise or dividend/share buyback, there's no way around it.
More germane to HN: I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie? C'mon dude, admit you're wrong and move on.
No I'm not. I've always referred to market cap, never accounting.
> I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie?
At the moment of the transaction yes, it's neutral. You could use the money you just raised to buy back the shares you just issued and be back to square one. That's all I am saying and it's a basic point taught in finance classes. In fact if what you suggest happened, and the share value tanked you'd have a perpetual money making machine. Just raise a bunch of capital, watch your stock tank, buy back shares and end up owning the whole company again plus some left over cash.
That doesn't mean that raising capital can't in the long term add or destroy value in a company, it's just not the transaction that does it, it's what you do or don't do with the money. If you use the money so that the total employed capital has a higher rate of return than just the original one, the value goes up, if not it goes down.
Also, you can't put the genie back in the bottle and buy back as you keep proposing. Because the market gets its say. Even if there were sufficient liquidity (shares available to purchase) there's no reason to expect the price would remain constant. And if I own 49.9% and BigCorp owns 50.1%, you can imagine that share price is not going to be "pedrocr math." The world doesn't work like a basic bookkeeping class.
Ok, so what price would the market set for a share in the company we discussed before? Assume the original 10$ valuation was fair and that there are now 100 shares after issuing 90$ worth of new ones. What's the new price? Above or below 1$?
However I went from holding 10% of a company to 1% of a company. If I was holding the stock because I thought the company would sell for 100x my investment -- $100 sale to a competitor and that I'd get $10 -- well, now I'm a 1% owner and it doesn't seem like they're going to sell. And I'm also not likely to be interested in holding a $1 stock for potential payoff of $1. (Since I know their burn rate is $10/month and now increasing, I don't give a damn about the cash on hand, never did.)
How about other scenarios?
a) The company announces it's entering a brand new, high-risk market and it's issuing 90 new shares on the open market. Market opens. What's the price?
b) Same as a) but company announces it will be suspending its dividend for 1 year. Market opens. What's the price?
c) Company announces that it entered into a strategic marketing agreement with Salesforce in exchange for a private issue of 90 shares at $1. Market opens. What's the price?
d) Company announces it granted 90 options to its new star CEO and issued 90 shares to cover. Market opens. What's the price?
e) Company announces it borrowed $90 from Warren Buffett at 10% interest and also gave him warrants for 90 shares at $1. Market opens. What's the price?
> I've always referred to market cap, never accounting.
Not true. Which is why my next test question was going to be: the company went public at $10 last year before dropping to $1. So there's $190 in shareholder's equity against 100 shares and $90 cash on hand. Market opens, what's the price?
The core flaw of your argument is that the company can't control the market price. So there's no such thing as a "neutral market cap" transaction that changes the number of shares and you certainly can't "undo" it just because the numbers line up on the balance sheet. Specific to your core error, look up P/B ratio.
This whole thread apparently got linked from elsewhere and "We've limited requests for this url" is the error given. It's been fun guest lecturing here but I believe our overlords signaled that it's time to free up resources.
For anyone who's followed this long, read "Security Analysis" by Benjamin Graham for real insights instead of this incomplete thought experiment gone awry.
This is just rude as have been other posts. I haven't made any excuses, just arguments, which you have generally failed to engage and just thrown in more and more complexity into the mix.
> but the answer is: whatever the market decides. I've decided I want to sell my share. I now have to find someone willing to buy it. The spread alone guarantees I'm not going to get $1 for it.
Congratulations, you've found a way to extract free money from the market:
Cenario A: The transaction happens and the price is now above 1$. Great, there is now at least one person out there willing to buy a share for more than 1$. The initial shareholders should be ecstatic, just taking 90$ in exchange for 90 shares has allowed them to sell at least one share for more than 1$, whereas yesterday they could only get 1$ for them. Free money!
Cenario B: The transaction happens and the price is now below 1$. Great, there is now at least one of the shareholders (new or old) that is willing to sell one or more shares for less than 1$. Take 1$ from the 90$ you just raised and buy back the share. The remaining shareholders get to keep the change. Free money!
This doesn't mean that movements in price can't accompany capital raises. But what causes that movement isn't the transaction itself it's what it means. If a bank suddenly announces it has raised capital to cover larger than expected loan defaults the share price will decrease, because of the defaults not the capital raising transaction. If a manufacturing company announces it has raised capital to increase it's capacity in a booming market, the price may very well rise, not because of the capital raise, but because the expectation is that the company will be more profitable in the future.
The point, and this is my final comment, is that raising capital doesn't by itself change the share price of the company, but what the transaction implies may very well do. In the bank case the revelation of past problems lowers the price, in the manufacturing example the expectation of future profits does. Never the transaction itself which is the same in both cases.
> For anyone who's followed this long, read "Security Analysis" by Benjamin Graham for real insights instead of this incomplete thought experiment gone awry.
The book recommendation sounds great to me. I'd add the recommendation for a good finance textbook as it may help find some of those mispriced opportunities that Graham talks about. If you suddenly find a company that has just raised money being valued at less that previous_value+raised_money it may pay to look into if there's an opportunity or if there's a reason the price is lower (the expectation that the company will blow through the money without generating enough profit).
First, I think your example of dilution and it's impact on returns is a good one.
Dilution - a nice neutral definition can be found here:
http://www.investopedia.com/terms/d/dilution.asp
A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur when holders of stock options (such as company employees) or holders of other optionable securities exercise their options. When the number of shares outstanding increases, each existing stockholder will own a smaller, or diluted, percentage of the company, making each share less valuable. Dilution also reduces the value of existing shares by reducing the stock's earnings per share.
I sense we were overly focussed on the impact to the balance sheet, and ignoring the impact on share of earnings, so I will grant you that Dilution's impact on EPS (and, eventually share of dividends), is a reason that shareholders might resist Dilution.)
But, I think it's important to recognize a couple things. First, issuing shares does not always create downward share price pressure. It's quite often the case (particularly in startups), that an infusion of cash has a significant upwards impact, as the liquidity may now make the company much more valuable.
Another good example might be Apple, back in 1997. Microsoft's $150 million got 150,000 shares of stock. That liquidity injection (at a pre-split price of $2.50) gave Apple an important boost at an important time - that I would argue created upward share price pressure.
On the flip side - http://www.investopedia.com/articles/stocks/11/dangers-of-st... has a nice writeup on how to deal with issues surrounding dilution.
Specific to the MSFT/Apple deal you mention -- and more notably as part of Warren Buffett's deals with GS/BofA/GE -- those were preferred and non-voting shares. So there was no dilution in either EPS or voting control.
Microsoft re-assuring that it would continue to produce Office for Mac affected the price. Apple taking out what was effectively a $150 million loan at 6% interest was not the source of the excitement.
Buffett's deals also included warrants. I can no longer devote time to being the thread savior here but I'd encourage anyone reading this to walk through those deals and think through the implications. It's pretty interesting stuff.
As any startup founder knows, the art is to issue just enough shares to fund the company to grow to success -- and in fact, to do this in stages, each time issuing only enough shares to make it to the next milestone.
In practice, for large companies, the quantity of shares issued is generally small and gradual enough that any dilution is factored in gradually to the share price.
1) The mechanism by which you move money in/out of a company. At the moment of the transaction you add/remove X$ in cash to the company and add/remove the same X$ in shareholders. You could turn around and use that same cash to do the opposite transaction and be back to square one. That's what I mean by the transaction being neutral to shareholders.
2) The situations in which you are incentivized to do these share issues/buybacks and their long term impacts. If you believe that your company is currently valued at Y but is really worth 10Y then you want to raise as little as possible to get a bigger share of that 10X increase in value. Conversely if you think your share is overpriced you want to raise as much as possible because you are paying it with inflated shares.
The transactions themselves are neutral to the shareholders at that point in time, they're just ways of moving cash in/out of the company, you do them more or less and in one direction or another depending on your evaluation of how mispriced the company is.
I've spent a lot of time reading Buffet, and he's pretty clear that he doesn't believe in equity-based compensation for employees. He believes that if employees want to own part of the company where they work, they should take their salary and go buy stock on the open market.
So, at least Buffet is consistent in his own view of the world. He's no hypocrite, and he's not guilty of what the author is accusing him of. The author should go read more of Buffet's writings.
That being said, I disagree with Buffet and believe that the Silicon Valley model of throwing equity compensation to rank-and-file employees is justified. The author's point that share buybacks don't all go to the shareholders is definitely true in general. But it is certainly less true or not true at all with regards to Berkshire Hathaway (Buffet's company).
Instead of investing in R&D, buying assets, streams of income, creating new products, renovating facilities, or even paying your own people, a stock buyback says that all of those things are basically a worse ROI on the business than just handing the money over to shareholders.
In general, I think my professor was right. I think there are good reasons to potentially buy out investors and so on, but usually these programs are done under the guise of making shareholders richer, but I just don't see that as the case.
The best way to enrich shareholders is by simply giving them a dividend, or by running a more profitable business (which will drive up the stock price).
Everything else is basically financial machinations that look good, but are mostly meaningless.
For a really simplified example. Let's say there's a company that simply holds $100. No revenue or expenses. It's got 100 and that's it.
And say there are two shares total and two shareholders. Me and some other guy. So each share is worth $50.
Say the company does a buy back and spends 50 to buy the other guys share. Now I own the whole company but it's only worth $50. So I'm no better off than before.
What am I missing?
Nothing. Buybacks are a way to return cash to shareholders, just like dividends, with different tax implications.
In your example the company has used the share buyback to return 50$ to shareholders. If it wanted to do it evenly it could even do a stock split first turning every 50$ share into two 25$ shares and then buy back one share from each person. That would be functionally equivalent to doing a 25$ dividend per original share but have different tax implications (capital gains are cheaper than income taxes in most places).
You're just looking at yourself and not the entire class of shareholders. Buybacks are positive for shareholders who want to cash out. As well, the additional demand for shares tends to boost the share price.
In a contrived example where a company is totally valued by its cash balance, you have the appearance of a wash. But if a company's worth is determined by revenues exceeding expenses (profit margins) rather than cash balances, you can boost the share price beyond e.g. $50 with the increased demand, where the share price is not a simple function of cash balance but has expected cash flows as a major component.