What’s New With Stock Buybacks?
Public Company Forum: Spring 2012
April 25, 2012
Stock buybacks have enjoyed a resurgence in 2011 and early 2012 as companies seek ways to put extra cash to work. Several factors have combined to breathe new life into this old stand-by. First, the economic downturn has led to a well-documented decline in cash-consuming acquisitions. For example, Bloomberg reports that first quarter 2012 acquisitions were down 14% from the fourth quarter of 2011. And while investment in new products and facilities has picked up since the dark days of 2009, it remains muted. It appears that, even though the operations and cash flow of many companies have stabilized or improved, many executives remain reticent to commit to major expansion projects, and many would-be sellers seem determined to wait for valuations to rise before striking a deal.
In the meantime, cash has increased to record levels at many companies, and pressure is building to put it to use. Some companies see this as an easy, investor-pleasing opportunity to return capital to stockholders. Other companies have been forced into it, kicking and screaming, by unhappy investors and analysts. For example, on March 18, Apple was finally persuaded to part with $10 billion of its $100 billion cash hoard through a new stock buyback program.
But first, a quick refresher on the basics…
Benefits of a Stock Buyback Program
The most commonly cited advantages of a stock buyback program can be summarized as follows:
- It is a tax efficient way to return capital to stockholders.
- It signals the market that the company believes its stock is undervalued and is a good investment.
- It reduces dilution from prior stock issuances, such as equity-based employee benefit plans or acquisitions.
- It can improve key financial measures, such as earnings per share or other ratios that may have significance for a company’s credit facility or indenture covenants.
- For a thinly traded stock, it may provide temporary liquidity.
Things to Watch Out For
As with all financial strategies, several other issues must be considered:
- Buybacks can subject a company to criticism that it is simply trying to manipulate financial measures to maximize executive performance-based compensation and instead should be using the money to reduce layoffs, expand operations, increase research and development or otherwise invest in the company’s long-term future.
- Be careful that the buyback does not push any non-participating stockholders over key stock ownership thresholds, such as 5%, 10% or 50%, which could inadvertently trigger unwanted SEC filings, loan covenants, poison pill limits or the like.
- Before authorizing a buyback, the board of directors must identify a proper corporate purpose in order to fulfill its fiduciary duties. Common considerations may include the company’s current cash position, the foreseeable impact on the company’s future capital requirements and other alternative uses it may have for the cash. Be sure to check your state’s statutes for applicable rules, such as balance sheet surplus requirements.
- All buybacks should be executed in accordance with the Rule 10b-18 safe harbor from market manipulation liability.
- Carefully monitor compliance with anti-fraud prohibitions of Rule 10b-5. Because the company is the ultimate insider, no repurchases may occur when there is material non-public information. This means that the company must be prepared to suspend the plan even when the trading window is open. (See, however, the discussion of Rule 10b5-1 plans below.)
- The company also may need to suspend the buyback plan to comply with Regulation M, which limits repurchases during a public offering.
- Repurchased shares must be reported quarterly in SEC reports.
Two Interesting Twists
Accelerated Stock Repurchase Programs
Accelerated stock repurchase programs have been around for a while, but like traditional buybacks have become increasingly popular. Basically, the company buys a large block of stock directly from a dealer, rather than in the open market, generally due to market liquidity constraints. At the end of a negotiated period (often 30 days), there is a purchase price adjustment where the company pays the dealer for any increase in the stock price during the period, when the dealer is covering his short position, or the dealer pays the company if the price of the stock has fallen. The dealer receives a negotiated fee.
The reasons to implement an accelerated stock repurchase program vary somewhat from those of a traditional stock buyback:
- As their name indicates, accelerated stock repurchase programs accelerate the financial metric benefits mentioned above, such as the impact on earnings per share, rather than spreading them out over a longer purchase period.
- Because the dealer has flexibility regarding the exact timing of purchases in the open market during the negotiated period, it often can obtain a better average purchase price, and can pass that benefit along to the company.
- Another benefit to the delay between the delivery of funds to the dealer and the final settle up is that the dealer can earn a return on those funds during that period, perhaps higher than the company could have earned, and return that benefit to the company in the form of a discount.
- So long as the accelerated stock repurchases are launched when the company has no material nonpublic information, the dealer can purchase shares in the open market even during blackout periods because the dealer has absolute discretion over the purchases.
Effecting Buybacks under a Rule 10b5-1 Plan
Because Rule 10b-18 only protects the company from market manipulation liability, but not liability for trading while in possession of material nonpublic information, some companies use Rule 10b5-1 plans to effect their repurchases. Much the way executives should trade only under a written 10b5-1 plan because of their ongoing access to inside information, the company benefits from following the same advice.
The downside is that the company has limited ability to terminate or modify the 10b5-1 plan, which can be disconcerting to a CFO or Treasurer who wants to maintain more control over the buyback process. These concerns can be mitigated, although not eliminated, by creating a 10b5-1 plan that is short in duration and contains “circuit breakers” that discontinue the formulaic repurchases in the event, for example, that the stock price exceeds certain volatility parameters.
Is It for You?
Stock buyback programs have moved to the forefront of many companies’ cash management and market strategies. If you have not done so recently, we encourage you to consider whether it would be a useful technique for your specific situation.
Additional Articles from the Spring 2012 Public Company Forum:
Doug's Note: The JOBS Act
"Don't Pay Me, or Else!": Extorted or Culturally Compelled Payments to Foreign Officials
Say on Pay: We Got an “A+.” Should We Still Worry?
What’s Market? Are Non-Binding Auditor Ratification Votes “Required?”
Dodd-Frank Act Progress Report: Spring 2012