Wednesday, September 26, 2012

Second Quarter Stock Buybacks Rise

This recent S&P Dow Jones Indices press release summarizes share repurchases for the second quarter among the companies that make up the S&P 500.

According to the press release, there have been $ 788 billion in buybacks by the following 20 companies since the 4th quarter of 2004. In fact, there has been $ 2.81 trillion in buybacks by all the companies in the S&P 500 over that same time frame.

A rather impressively large number to say the least.*

Here's the twenty largest 2nd quarter buybacks:

- Johnson & Johnson (JNJ) $12.85 billion

- Exxon Mobil (XOM) $5.01 billion

- ConocoPhillips (COP) $3.05 billion

- Intl Business Machines (IBM)  $2.99 billion

- AT&T (T) $2.56 billion

- Oracle (ORCL) $2.40 billion

- Wells Fargo & Company (WFC) $2.04 billion

- American International Group (AIG) $2.00 billion

- Cisco Systems (CSCO) $1.89 billion

- Wal-Mart Stores (WMT) $1.84

- American Express (AXP) $1.78 billion

- Philip Morris International (PM) $1.63 billion

- The Coca-Cola Company (KO) $1.53 billion

- The Goldman Sachs Group (GS) $1.50 billion

- The Home Depot (HD) $1.50 billion

- JP Morgan Chase & Co (JPM) $1.44 billion

- Intel Corporation (INTC) $1.40 billion

- DIRECTV (DTV) $1.35 billion

- Pfizer (PFE) $1.34 billion

- News Corporation (NWSA) $1.30 billion

During the quarter, the top 20 bought back $51.39 billion while all companies in the S&P 500 combined bought back $ 111.75 billion.

J&J's buyback comes as part of a deal to buy Synthes for roughly $ 20 billion that is summarized here. It's the biggest deal in the company's 126 year history and was financed with roughly 65 percent stock and 35 percent cash.

This 8-K filing provides more details. Essentially, they are using foreign cash held at an Irish subsidiary (Janssen Pharmaceutical) to buy back $ 12.9 billion of J&J's shares.

This J&J press release to announce U.S. regulatory clearance for the deal also explains the financing of this transaction.

Janssen Pharmaceutical, a wholly owned Irish subsidiary of Johnson & Johnson, has entered into accelerated share repurchase (ASR) agreements with Goldman, Sachs & Co. and JPMorgan Chase Bank, N.A. to purchase a combined total of 203.7 million shares of Johnson & Johnson common stock for an initial purchase price of $12.9 billion.

Here's how the deal is financed. Those shares bought via the ASR agreements along with cash on hand at the subsidiary will then be given as merger consideration to Synthes shareholders. So, unlike most other buybacks, it's not as if this one by J&J is going to result in a reduction in share count. It's simply going to prevent the share count from going up as a result of the transaction.

The reason for the financial gymnastics is to prevent a big U.S. tax bill.

The ConocoPhillips buyback may not have been the biggest in dollar terms but, if their buyback rate continued for an entire year, it would amount to 17 percent of Conoco's current market value. In fact, DIRECTV, AIG, AmEx, and Goldman Sachs all were buying back at an annualized rate that, if continued for a full year, would represent 10 percent or more of their current market value.**

Obviously, these companies may not necessarily continue to buy back at the same rates (nor should they if the share price doesn't represent a nice discount to value) but these actions do represent impressive proportions of total market value. Naturally, when the price drops a larger number of shares can be bought back for the same amount of cash. Unfortunately, these stocks are not nearly as cheap as they were not all that long ago. The inevitable, arithmetically certain, outcome being that these buybacks would be even more effective if they were still at or near those lower valuations.

So a long-term investor shouldn't generally want shares of a sound business they own to go up in the near-term. What's an exception to this? Here's one scenario to consider. Unfortunately, there's the very real risk that a buyout offer comes in at a premium to market value but a discount to intrinsic value. If enough owners are okay with the gain that will have occurred compared to the recent price action, the deal may be approved. If too few have conviction about longer run prospects, the deal may get approved. When too many owners of shares are in it for the short-term or, at least, primarily to profit from price action, the chance of this happening increases. Well, those that became owners because of the plain discount to intrinsic value and the company's long run prospects will likely get hurt in this scenario.

Otherwise, a long-term investor (who judges intrinsic value well, of course) should generally want the price to go down in the near-term or even longer. Warren Buffett provides a useful explanation of this using IBM as an example in the 2011 Berkshire Hathaway (BRKaShareholder Letter. Also, here's a prior post on the same subject: 

Why Buffett Wants IBM's Shares "To Languish"

That's why it matters a whole lot for a high proportion of the board, management, and other owners (especially those who are influential) of the stock have potential long-term value creation over short-term gains in mind. 

That's why it matters if there are fewer traders and more true long-term owners controlling the shares outstanding.

It's also why it matters that long-term prospects are well understood by the board, management, and owners even if real short-term challenges have pressured the stock price. All of this must be carefully considered by an investor.

Adam

* Unfortunately a disproportionate amount was done throughout 2007 and early 2008 when the market was at or near its peak. So the fact that buybacks have risen recently hardly says much about where stocks are going in the near-term and even longer. Buybacks only makes sense when shares sell below intrinsic value, the company is otherwise well-financed, and the investments needed to maintain/increase competitiveness can still be made. Ideally, buybacks should (and actually would) mostly occur when the discount to value is clear and substantial. 
** The annualized buy back rate for DIRECTV would be equal to 16 percent of current market value. AIG = ~ 14 percent. AmEx = ~ 11 percent. Goldman Sachs = ~ 10 percent. AIG's buybacks, of course, follow the massive dilution that occurred to the company's share count during the financial crisis.

Johnson & Johnson and Synthes Announce Definitive Merger Agreement - 8-K Filing

Johnson & Johnson Announces Completion of Synthes Acquisition - 8-K Filing

Keywords: Buyout below value, going private below value, premium to market value but discount to intrinsic value.
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