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Whitney Tilson on Share Buybacks

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Whitney Tilson on Share BuybacksFrom Whitney Tilson:

The issue of share repurchases has been on my mind recently because last week I attended an investor meeting with the CFO of a stock we own and, at one point in the meeting, a shareholder attacked him for the company’s share repurchase program, saying it was destroying value and challenging him to name a single example where share repurchases worked.  The CFO was very defensive and almost apologetic in his weak response, to I immediately spoke up and made the case that the company should be buying back every share it could at today’s deeply undervalued price, and then followed up with this email:


Dear XXX,


I enjoyed meeting you and liked what you had to say, though I thought (as I said in the meeting) that you could have been stronger in answering the guy (who I’m sure is fairly typical) who criticized your share repurchases.  It seemed like you were apologizing for it rather than forcefully defending your repurchase program, explaining why it’s a great use of your cash, and rebutting the nonsense the guy was saying.


Given that this issue really isn’t particular complex, it never ceases to amaze (infuriate?) me how few companies and investors think sensibly about share repurchases.  Once a business has a strong balance sheet, then it should first take its excess cash/cash flow and reinvest in its own business – if (and only if) it can generate high rates of return on such investment (witness Wal-Mart for its first 40+ years, for example).


Then, if it still has cash/cash flow left over, it should return it to shareholders, who are, after all, the owners of the business – it’s THEIR cash.


This leaves two questions:


1) Should cash be returned via dividends or share repurchases?  That depends on the price of the stock vs. its intrinsic value.  If the stock is trading somewhere +/- 20% of fair value (this is a rule of thumb, not scientific), then dividends.  If it’s trading at a 20% or greater discount, buybacks.  (And if it’s trading at a big premium to fair value, then ISSUE stock, either in a secondary or use it as an acquisition currency.)


My view is that your stock is EASILY worth twice its current price, which means that every dollar you spend buying back your stock creates TWO DOLLARS of value for shareholders!


2) What about acquisitions?  Studies show that 2/3 of all acquisitions destroy value – yet every company, with every acquisition, thinks they’ll beat these odds.  I’m not going to quarrel with small acquisitions to round out your product offering, but PLEASE don’t follow HP’s example with two of the dumbest acquisitions of all time, Palm and Autonomy.


To some extent, the amount and pace of your acquisitions should be rooted in the price of your own stock.  Even if you were getting a fair price, why would you issue stock or cash to buy some other company when you can buy more of your own company at HALF its intrinsic value???


I’m sure it must really irritate you and others in management how the market is showing so little respect for your excellent business.  At its current price, the market is either saying your business is terrible and about to go off a cliff and/or management is terrible and is going to destroy value.  I don’t think either is true – as I’m sure you’d agree – so the best way to get back at the investors who are disrespecting you is to buy as much stock as you possibly can – and then watch it skyrocket when you continue to execute and report good earnings, which will be juiced with a much lower share count.  As I mentioned in the meeting, if you continue to buy back stock like you did last quarter and the stock doesn’t move, you can buy back 25% of your outstanding shares in the next two years, which will boost earnings per share by 33% or 15.3% annually, even if your net income is flat.  That’s HUGE!


Rather than being irritated, you should be gleefully rubbing your hands together at the opportunity to buy back a ton of your stock at such a MASSIVE discount to its intrinsic value.  Don’t hesitate – this opportunity might prove to be fleeting, and share repurchases at a 25% discount to intrinsic value aren’t nearly as accretive.


As background reading, I’ve attached:

1) Warren Buffett on share repurchases from his 1999 annual letter:

Berkshire Hathaway 1999 Share Repurchases, Excerpt(function() { var scribd = document.createElement(“script”); scribd.type = “text/javascript”; scribd.async = true; scribd.src = “http://www.scribd.com/javascripts/embed_code/inject.js”; var s = document.getElementsByTagName(“script”)[0]; s.parentNode.insertBefore(scribd, s); })();
2) My comments on Buffett’s recent share repurchase announcement:

Berkshire Hathaway’s New Share Repurchase Program – And What It Means-9-26-11(function() { var scribd = document.createElement(“script”); scribd.type = “text/javascript”; scribd.async = true; scribd.src = “http://www.scribd.com/javascripts/embed_code/inject.js”; var s = document.getElementsByTagName(“script”)[0]; s.parentNode.insertBefore(scribd, s); })();

3) A presentation Leon Cooperman gave in 2007 on share repurchases, focusing on how Henry Singleton of Teledyne created ENORMOUS shareholder value over a long period of time by using his stock as an acquisition currency when it was richly valued during the 1960s bubble, and then bought back huge amounts of his stock when it was cheap during the gloom-and-doom 1970s:

Leon Cooperman Value Investing Congress-Henry Singleton(function() { var scribd = document.createElement(“script”); scribd.type = “text/javascript”; scribd.async = true; scribd.src = “http://www.scribd.com/javascripts/embed_code/inject.js”; var s = document.getElementsByTagName(“script”)[0]; s.parentNode.insertBefore(scribd, s); })();

By the way, the single best example is in Leon Cooperman’s slide presentation I attached to my last email: Teledyne under Henry Singleton.

2) I followed up with this email:

Dear XXXX,


I trust you saw this article in yesterday’s WSJ.  It correctly highlights the fact that most companies do share buybacks all wrong, buying when their stock is high/overvalued and not buying when it’s low/undervalued, thereby destroying massive value.


However, the article also provides a wonderful case study you can use to rebut guys like the one in the meeting last week who challenged you to name a single example where share repurchases worked:

The case of International Business Machines Corp. shows how buybacks can be a boon to both a company and its investors. Since the end of 2006, according to regulatory filings, IBM has repurchased $60.3 billion of shares that would be worth more than $91 billion today. More than 60% of those 504 million shares remain off the company’s books; that means they haven’t been replaced, for example, by shares issued as part of executive pay packages.

Partly as a result, IBM’s shares outstanding have declined by a fifth over that period and its stock price has nearly doubled. While it has increased its per-share dividend by 150%, its overall dividend costs have increased just 100%.

“Over the last decade, we invested about $70 billion in capital expenditures and acquisitions (116 companies) and nearly $60 billion in research and development targeted toward high-value areas,” an IBM spokesman said in a statement. “We returned $89 billion to our shareholders as share repurchases and at the end of 2010 our quarterly dividend was five times higher than in 2000.”

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