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Finance: Stock buy backs - who are the real beneficiaries?

After last year's dramatic decline, stock buybacks have surged in 2010 as companies bank on the fact that their stock is a good investment. It is also a way to return money to shareholders, because it juices earnings per share by reducing the denominator, which, all other things being equal, will then lift the share price. At the very least it can prevent dilution when shares are distributed for stock options or other purposes and it is this aspect of stock buybacks that is particularly important in family-controlled companies.

"The matter of dilution of control is extremely important, even in large public companies," says Norb Schwarz, senior advisor at the Family Business Consulting Group.

Beyond that, recent announcements by big companies with significant family ownership display the full range of variations on motivations for buybacks. In June, Cablevision Systems announced a $500 million share repurchase programme – its first ever – in conjunction with the $1.37 billion acquisition of another cable operator, Bresnan Communications. The stock buyback was widely seen as a sop to shareholders who were jittery about the company's somewhat chequered history of acquisitions – such as the 2008 purchase of a loss-making New York suburban newspaper.

"We believe that the repurchase programme will help to better align the market value of the company's common stock with Cablevision's underlying operating performance," chief executive Jim Dolan, son of founder Charles Dolan, said in announcing the plan.

The acquisition-buyback move by Cablevision followed actions earlier in the year by US chip maker Qualcomm and Belgian chemical giant Solvay.

In March, the Jacobs family controlled Qualcomm announced a $3 billion stock repurchase programme together with a 12% boost in its quarterly dividend in an effort to recuperate some of the ground it lost when a disappointing revenue forecast knocked nearly 25% off the share price.

At the annual meeting in March, shareholders expressed considerable frustration with the share price, given that the biggest maker of silicon chips for mobile phones was in one of the hottest businesses on the planet. "In 2001, the stock was $45, and today it's $37," one shareholder said. "With the kind of company Qualcomm is, this stock should be a lot higher than $37. It is astounding to me."

Paul Jacobs, the second-generation CEO, agreed that it was astounding, especially since the company had doubled revenue and earnings per share in that period, as well as accumulating nearly $20 billion in cash.

"The only thing we can do is continue to return value to shareholders through dividends and share buybacks, and continue to drive the business forward," he said. "But we share your frustration." The $3 billion share repurchase programme, which represents about 5% of outstanding capital, replaced an earlier one that had successfully used up $1.7 billion of its allotted $2 billion to buy back company stock. The company trumpeted the fact that it had returned $12.6 billion to shareholders in dividends and share repurchases since beginning that programme in 2003. But that didn't convince stock market investors – the share continued to languish and ended the month of June very near its 52-week low just below $33.

Solvay, the Belgian chemical giant still 30% owned by the sixth generation of the founding family, was the mirror image of Cablevision. The sale in February of its pharmaceutical business to Abbott Laboratories of the US for €4.5 billion gave it a different problem – where to park the €1.7 billion net capital gain realised in the transaction.

The solution, non-family chief executive Christian Jourquin explained in a conference call, was an investment programme in treasury shares of up to 5.1 million shares, representing about 6% of its capital. "Temporary investment and opportunistic investment in our own shares is more attractive than current loan money market yields," Jourquin said.

Solvay officials made it clear, however, that they were not buying up the shares to cancel them and that at some point they could be sold back into the market. The stock buyback met the two criteria the company had for the short-term reinvestment of its cash, CFO Bernard de Laguiche explained – preservation of capital and flexibility, so that the cash is available when needed.

Also, de Laguiche added, the share repurchases provided the company with a hedge for its own stock option programme, echoing a strategy that many companies follow with stock buybacks of avoiding equity dilution through employee stock option plans. Yet another variation on the theme came with Dutch brewer Heineken's announcement in July that it would use buyback authority granted in April to purchase shares for delivery to FEMSA of Mexico as part of its deal to acquire that company's beer business. Heineken said it had already purchased 5.5 million of the 29 million shares it must deliver to FEMSA and would purchase up to €150 million more of shares through mid-November. As with a share repurchase programme to compensate for stock options, the Heineken move seemed designed to avoid dilution for existing shareholders.

Buyback cop-outs

However, Standard & Poor's, noting that stock buybacks for companies in the S&P 500 registered a nearly 80% increase in the first quarter, have a different take on the buyback trend.

"Companies have officially returned to the buyback market," said Howard Silverblatt, senior index analyst. "However, their purchases appear to be aimed at neutralising employee options, and therefore are preventing earnings dilution."

Buybacks in the S&P 500 increased to $55.3 billion from the $30.8 billion in the first quarter of 2009 – though still only a fraction of the peak $172 billion reached in the third quarter of 2007. The 2010 figure also represents a 15.6% gain from the fourth quarter of 2009, marking the third quarter in a row that the companies showed an increase in buyback activity. Some 251 issuers participated in stock buyback programmes in the first quarter of 2010, S&P said, up from 214 in the fourth quarter of 2009 and 194 in the first quarter of 2009.

For one thing, S&P notes, companies have a lot of cash on hand. S&P 500 firms, excluding financial companies, had just over $1 trillion in cash at the end of the first quarter, representing 10.6 % of total assets, compared with $811 billion at the end of the first quarter in 2009, or 9.2 % of assets.
Cash-rich companies often prefer to return money to shareholders through stock buyback programmes rather than by raising the dividend, because they are reluctant to cut the dividend in leaner times. Buybacks give them more flexibility. Yet market participants argue about their significance. For some, it is a bullish sign that companies are feeling
confident about the direction of their earnings and their share price. Historically, a rebound in stock buybacks can signal a rebound in the overall market.

For others, buybacks represent a failure of imagination, as companies use their cash in a relatively non-productive fashion instead of investing it in new capacity or even in an acquisition. The massive accumulation of cash currently is in itself a bad sign, these analysts argue. 
"Why can't companies use their cash resources to expand the company and grow their earnings?" asks consultant Schwarz. "It's kind of a cop-out." Bill Lazonick, director of the University of Massachusetts' Center for Industrial Competitiveness goes even further. He accuses companies of buying back shares to manipulate the value of executives' stock options upwards – a cynical self-dealing cloaked in the language of shareholder value.

In the early 1990s, according to data compiled by Lazonick's centre, stock repurchases represented some 23% of net income of S&P 500 companies. Later that decade, buybacks equaled 44% of net income, and by 2007, an eye-popping 91% – meaning that companies were ploughing most of their profit into share buybacks that mostly benefited only top management. For that reason, Lazonick is generally opposed to stock buybacks. He does concede, however, stocks can be bought back to reintegrate ownership and control.

"Then it is a question of how that reintegration of ownership and control is used," Lazonick says. "It may be a way of shielding the company from the short-term pressures of the stock market for the sake of long-term investment in productive capabilities."

In short, while on the surface buybacks may seem beneficial to shareholders, it might require more in-depth analysis to determine just where the benefit is going.

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