Buybacks or Giveaways?

A raft of companies have recently announced plans to repurchase their stock. This may not be such a hot idea.

Call it buyback mania.

With the price of equities plummeting — and with it, investor confidence — corporations have started repurchasing stock at a dizzying pace. According to Trim Tabs, a company that specializes in tracking and analyzing market liquidity, publicly traded companies so far this year have bought back at least $30 billion worth of stock.

Last month alone, more than 100 companies, including Merck, PepsiCo, Citigroup, and Home Depot, initiated programs to buy back over $43 billion in stock. That makes July the biggest month for buyback announcements since last September, when corporates launched $54 billion in buyback programs following the 9/11 terrorist attacks.

The September numbers were not surprising. Companies often buy back stock during times of crisis and equity downdrafts. After the stock market swoon in October 1987, for example, a staggering 777 publicly traded companies announced repurchase programs. The slew of corporate buybacks helped spark a stock market rally, boosting the Dow Jones Industrial Average by 11.5 percent by year-end.

Likewise, in the three weeks after Sept. 11, 131 companies said they would buy back at least 5 million of their own shares. The repurchases fueled a minor recovery on the major U.S. exchanges.

In fact, many finance executives believe repurchase programs send a clear signal that a company’s stock is undervalued. By scooping up outstanding scrip, they say a company is able to steady the nerves of jittery shareholders. What’s more, a buyback reduces the supply of shares on the open market. That, buyback backers say, eventually drives the price of a company’s stock up.

And in fact, a study conducted by Prudential Securities analyst Ed Keon would seem to bear this out. Keon looked at all the companies that conducted buybacks from 1984 through the second quarter of 2001. He found that corporations that reduced their outstanding shares by at least 1 percent generated greater annualized stock returns than the S&P 500 index.

But some critics say an open-market buyback is not the slam-dunk it might appear to be. In an open-market buyback, a company pledges to repurchase shares over a period of time at the prevailing market price.

And that’s the rub. Purchasing a stock at the current trading price — rather than at a premium — can give the impression that the market valuation of a company’s stock is pretty much spot on.

Just getting the market to notice a buyback plan can be tough these days. Al Ehrbar, senior vice president at consultancy Stern Stewart, believes many investors have started to ignore open-market repurchase plans. Why the cold-shoulder? Because companies have routinely failed to follow through on their announced plans — or have taken forever and a day to complete the buybacks.

“It’s a much more persuasive communication to the market to buy back shares all at once through a Dutch auction or fixed-price tender offer,” Ehrbar contends.

In fact, some market-watchers say open-share buyback announcements are sometimes seen as red flags by the investment community. “It may be alarming to the market that a company sees no expansion opportunities out there,” explains Bob Willens, a tax and accounting expert at Lehman Brothers. “It can be a sign that a company can’t find anything better to do with its cash.”

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