While many CFOs are still casting a cold eye on spending requests for R&D, training, equipment, and hiring, some are warming once again to the idea of returning value directly to shareholders. Bloated with cash — S&P 500 companies had $820 billion of cash and cash equivalents on their balance sheets at the end of the third quarter of 2009 — publicly held companies are returning to the stock market to repurchase hundreds of billions of dollars of shares.
The quarterly dollar volume of buybacks plummeted a year ago, in the first quarter of 2009, to $12.3 billion, according to data supplied by Dealogic (see chart below). But the fourth quarter of 2009 saw a rebound, with dollar volume hitting $170 billion. Thus far this quarter, $97.9 billion of buybacks have been announced. Limited Brands, Phillip Morris, Lowe’s, Colgate-Palmolive, Amazon.com, and WellPoint are among the companies that have announced large buyback programs. The biggest announced this year is that of PepsiCo, which pledged to buy $15 billion of its shares by June 2013.
Why are companies returning cash to shareholders so soon after big declines in revenue and profitability just one year ago? It’s a signal, first of all, that “many companies are breathing a partial sigh of relief that the worst of the recession is over,” says Francois Mallette, head of the private-equity practice at L.E.K. Consulting, a shareholder consulting services firm. There’s been a “thawing” in C-suite attitudes about the economic turnaround and the credit markets, notes Mallette. “They have faith in operating cash flows, and to some degree the credit markets have revived. That gives them the feeling that they can go out and do a buyback,” he says.
But many companies are struggling with the decision whether to repurchase stock, adds Mallette. The intrinsic value of a company — used to determine if the company is undervalued by the market — is not easily measured, and board members often enter the discussion with preconceived notions about whether buybacks are worth anything. The executive management of companies that have announced buybacks thus far in 2010 deserve kudos for fighting through some of those issues and having some foresight, says Mallette.
After all, buybacks earn companies a very good relative return compared with other capital investments, and can do it relatively swiftly. The increase in earnings per share can signal to investors that the stock is undervalued, and a decrease in the number of shares outstanding can help propel the stock price upward. A buyback also increases a company’s leverage, whether it uses cash or debt to repurchase the shares. “The right amount of leverage is value-creating,” says Mallette.
But a buyback can also indicate pessimism on the part of executive management and the board. “It might be viewed as a negative for a high-growth company: it might say to investors that the company doesn’t have any project or activities that can achieve higher returns [than a buyback],” says Jeff Mahoney, general counsel at the Council of Institutional Investors.