By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics”
Importance of share buybacks
A lot of attention is being paid lately to share buybacks conducted by companies. Since the financial crisis of 2008, many companies went through the deleveraging process and improved their balance sheets by paying off debt. At the same time, interest rates remained extremely low. This facilitated and continues to facilitate a process where companies opportunistically take advantage of credit availability and channel it to payment of dividends, share buybacks, or recapitalizations. Significant share buyback programs by companies are now announced almost daily. Market indexes that track the performance of companies that repurchase shares as well as specific ETFs have been developed. For example, PowerShares Buyback Achievers Portfolio ETF (PKW) is based on an index that is comprised of US securities that have effected a net reduction in shares outstanding of 5% or more in the trailing 12 months. This buyback ETF provided a +176% return over the past 5 years and had significantly outperformed the S&P 500 Index, which returned only +106% over the same period. Index providers and ETFs add or delete companies from the index “retroactively” depending on their buyback activity in the past, usually the last 12 months. More active investors might do well by looking “proactively” for companies that plan to repurchase their shares in the near future.
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Based on a recent price of $25.55 per share, EMC Corporation (NYSE:EMC) has a market capitalization of $53 billion and an enterprise value of $49 billion. EMC also has approximately $6.9 billion in long-term investments on its balance sheet, which consist of debt securities with maturities longer than 1 year, part of them being held by VMware, Inc. (NYSE:VMW), EMC Corporation (NYSE:EMC)’s subsidiary. Based on diluted amount of shares outstanding (after adjustment for convertible debt) and taking into account long-term investments, the company’s adjusted market capitalization and enterprise value stand at $55 and $43 billion, respectively. Using this adjusted enterprise value figure, the company is valued at an EV/EBITDA multiple of x7.9, based on 2012 financial results and at an EV/EBITDA ratio of x8.3 based on annualized 9 months of 2013 financials. In the first nine months of 2013, EMC generated a free cash flow of $3.7 billion and expects to generate a total free cash flow of $5.5 billion for 2013. EMV owns a 80% stake in VMWare, which, based on a recent price of VMWare’s shares, is valued at $33 billion and represents 62% of EMC’s current market capitalization. Without going into more detailed calculations, the bottom line is that EMC Corporation (NYSE:EMC)’s “stub” without VMWare’s business is valued at an even lower EV/EBITDA multiple than the “consolidated” EMC.
EMC has a large share buyback authorization in place. Currently, the outstanding buyback authorization program calls for repurchase of 197 million shares. Over the last 5 years (fourth quarter of 2013 not included) EMC Corporation (NYSE:EMC) repurchased $8.6 billion worth of stock. Of this total amount, $5.6 billion was allocated to buyback of EMC’s shares, $1.2 billion to repurchase by EMC of VMware, Inc. (NYSE:VMW)’s shares, and the remaining $1.7 billion in share repurchases was done by VMWare itself. According to guidance provided by company, EMC expects to repurchase an aggregate of $3.5 billion of the company’s common stock in 2013 and the first half of 2014. During the first 9 months of 2013, EMC Corporation (NYSE:EMC) repurchased $2 billion worth of stock, and the guidance leaves investors with a $1.5 billion buyback commitment. Taking into account that EMC’s shares stayed almost flat in the fourth quarter while the S&P 500 returned 9%, it is safe to assume that the majority of remaining share repurchases will be done in first half of 2014. If EMC will continue to generate free cash flow at a similar rate going forward, share buybacks might become even more aggressive. For an active investor willing to go beyond share buyback ETF or index investing, EMC Corporation (NYSE:EMC) might provide an interesting alternative.