Monday, October 12, 2015

Activists & the AmEx Buyback, Part II

A follow up to this post. Last month news broke that an activist hedge fund, ValueAct Capital Management, had taken a stake in American Express (AXP).

Well, not long after the ValueAct stake was announced, Warren Buffett had the following to say about buybacks and AmEx in an interview on CNBC:*

"People assume when we buy some stock we want it to go up. We don't want it to go up. Maybe, obviously, eventually... five or ten years from now [we'd like it]."

He added "we love the idea" of a business with an already cheap stock "buying its stock cheaper. I mean that's happened at American Express", and since they're "a regular repurchaser of shares", Berkshire Hathaway's (BRKa) stake increases more quickly "if the stock is down than if the stock is up."

Buffett was then asked whether he likes to see an activist like ValueAct come into the picture with AmEx.

Buffett's response was "No not particularly is up to them what they do with their money. Actually it [sent the stock up] four or five points so the extent that American Express is repurchasing shares" it actually hurts AmEx long-term shareholders. He also said that "the cheaper the stock is the more shares American Express will be able to repurchase for a given amount of money and on balance...that helps us."

Each dollar used to buyback shares will have a smaller impact on share count. Plainly not a good thing for the long-term owner.

Fortunately the stock has come back down somewhat since Buffett said the above -- in part due to some of the market turmoil -- but, then again, maybe it would be down even more if there was no activist involvement.

The problem here is not at all specific to ValueAct. As I wrote in the prior post:

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

They just may.

It's just that whatever effect on the business they end up having, it will potentially have to offset the negative impact -- at least from the standpoint of a long-term investor in AmEx -- of the higher prices making the buyback activity less effective (if the higher stock price proves persistent and is directly related to the hope an activist will eventually have a favorable influence).

Now, whether or not AmEx must adapt more effectively to a changing competitive and technological landscape is an important and fair debate. If an investor comes along -- one who's in it for the long haul -- can contribute to such a debate that certainly wouldn't be the worst thing that could happen.

More from last week's interview with Buffett:

"...People make buybacks very complicated. [A buyback] makes sense when you are buying your stock back below its intrinsic value and when you don't need that money for the needs of the business. And it makes no sense when you pay above intrinsic value and that's a very simple principle but it has been ignored by many managements over time."

I know it might seem odd to think of a stock rallying as bad news but, if a good business with some extra cash is buying back shares that sell nicely below per share intrinsic value, that's simply how the math works -- especially in the long run. Depending on for how long, and by how much, the stock remains below intrinsic the effect on future per share intrinsic value can be anywhere from negligible to quite substantial.

The reality is it makes little sense, no matter how counterintuitive, to hope shares of a good business rally in the near-term when the plan is to be an owner for decades. Of course, this won't work if the enterprise proves fundamentally flawed in some way. Otherwise, for those in a position to consistently buyback shares over time any near-term (or even intermediate-term) rally will only reduce returns. In other words, a stock that sells persistently below what it's intrinsically worth can increase investor returns, all else equal, at less risk.**

Naturally, for those who plan to sell next week it's a very different story.

During the interview Buffett points out that he can't buy more shares of AmEx. 

The reason? 

AmEx is a bank holding company and Berkshire already owns as much as is allowed.


Long position in AXP and BRKb established at much lower than recent prices

Related posts:
Activists & the AmEx Buyback, Part I
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?

* These quotes, in some cases, differ very slightly from CNBC's unofficial transcript.
** This can, depending on the circumstances, also work for dividend reinvestments.

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