Tuesday, August 11, 2015

Activists & the AmEx Buyback, Part I

On Friday of last week, the news broke that ValueAct Capital Management, an activist hedge fund, had taken a stake in American Express (AXP).

Some might think, since the stock rallied right after the announcement, that this should be received as good news by AmEx shareholders.

Clearly, for a trader (or someone who intends to sell their AmEx shares in near-term) that's understandably the case.

Yet a long-term investor in the stock shouldn't necessarily view this development as being a good thing. At most, until more is known, it logically deserves a more mixed reaction.

This has nothing specifically to do with ValueAct. They may be very good at what they do and, depending on their intentions and capabilities, could even prove helpful to AmEx's prospects over the long run.

Then why should the reaction be more mixed? Well, consider that the company has already announced it intends to repurchase "up to $6.6 billion of common shares during the period beginning in Q2 2015 through and including Q2 2016."

When a company is repurchasing stock in a meaningful way -- and for one with a market value just over $ 80 billion I think buying $ 6.6 billion of its stock over 5 quarters or so qualifies -- no long-term owner should be happy about the shares rallying. It simply means that, if the recent rally in price proves persistent (or worse...goes higher), the funds used in the AmEx buyback program will go less far and, as a result, the share count will drop by a smaller amount.

Plainly, all else equal, that is not a good thing for the long-term owner.

Also, if the rally were to continue higher, at some point the price might become such that it makes no sense to continue buying back the shares (i.e. as the price gets closer to per share intrinsic value). Again, that further rally might satisfy those who are in for the short haul but makes little sense for those who plan on being continuing owners of AmEx shares for a long time.*

It comes down to this: shareholders who prefer for their investment outcomes to be driven by what the business can produce in excess cash over decades will, inevitably, have a very different agenda than those who emphasize profiting from price action. Of course, the long-term investor will eventually want to see the share price at least roughly track changes in per share intrinsic value. It's just that a delay in the recognition can be hugely beneficial.

AmEx repurchased roughly $ 1.2 billion during Q2 2015. Not quite on pace for $ 6.6 billion but reasonably close. At least for now it appears they are following through on the plan.

Yet that's not what's most important. While sometimes a buyback plan will not become reality, it's the reason they don't become reality that matters.

Buybacks can make sense when both a stock is cheap -- i.e. selling at a nice discount to per share intrinsic value -- and available funds are more than sufficient to meet all the operational/liquidity needs of the business.

Well, at times, a buyback program will continue to be implemented even if one or both of these things no longer proves true.
(Worse yet is a buyback plan that's been put in place for the wrong reasons and is then implemented.)

Unfortunately, buyback announcements like this aren't always followed by wise action based upon changing circumstances.

How price compares to value and business needs (and how these things change over time) must be considered. Rigidity, at least when it comes to buyback programs but also more generally, isn't a virtue.

In business and investing flexibility often wins.

In other words, it's possible that circumstances will develop such that what was once a well-intentioned buyback plan shouldn't be implemented.

Back in May of this year, Warren Buffett spoke on CNBC about activist investors in the context of it's largest holdings (of which AmEx is one).

Keep in mind that he said the following well before ValueAct decided to invest in AmEx:

"I think it'd be very silly for an activist to come in and say double your dividend today or buy in a whole lot more stock or whatever it might be they would be proposing. I think the companies are well run and I think their financial policies are sound."

He added that when you have "a well-run company, the best thing to do is just to sit back and enjoy it."

Naturally, this doesn't mean ValueAct won't ultimately end up having a positive effect.

They just may.

We'll see in due time what kind of activist role, if any, they intend to play.

More in a follow-up.

Adam

Long position in AXP established at much lower than recent prices

Related posts:
Activists & the AmEx buyback, Part II (follow-up)
Altria: Price Matters
Multiple Expansion, Buybacks, & The P/E Illusion
The P/E Illusion
The Benefits of a Declining Stock
Buffett's Purchase of IBM Revisited
Buffett on Buybacks, Book Value, and Intrinsic Value
Buffett on Teledyne's Henry Singleton
Why Buffett Wants IBM's Shares "To Languish"
Buffett: When it's Advisable for a Company to Repurchase Shares
The Best Use of Corporate Cash
Buffett on Stock Buybacks - Part II
Buffett on Stock Buybacks
Buy a Stock...Hope the Price Drops?

* Some might argue the long-term owner could simply sell and either wait for a better price to buy again or invest elsewhere. That approach sounds better in theory than it is in practice. When shares sell at a substantial premium to value or, for example, when opportunity costs are high there are times selling will be warranted. Yet, at least for me, this kind of behavior can be a recipe for unnecessary mistakes. There's usually a limit to the number of businesses one can understand well. Better to own some good businesses -- at least those bought at a discount and understood well -- for a very long time. Minimize frictional costs; minimize mistakes.
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