The Buyback Catch

With stock prices plummeting, why isn't Corporate America pumping up its repurchases?

One reason why cash is in short supply, of course, is that in addition to going on an acquisition binge during the past few years, corporations have invested heavily in their own stock. Hewlett-Packard, for example, spent more than $8 billion from November 1998 to October 2000 to buy back about 128 million of its shares. Today, those shares are worth about half that amount. The situation is similar at Microsoft, Intel, and AT&T, where much-heralded buyback programs are now being criticized because the total value of company shares has fallen more than $1 billion over the past two years. To make matters worse, many companies borrowed heavily to fund the buybacks, contributing to some of the 45 credit-rating reductions in 2000, according to Moody’s Investors Service.

The companies themselves offer no apologies. “We regularly purchase our own stock, determining through a set of metrics what we think the price of our stock should be,” explains a spokesperson for HP. “If it looks like the low end of that range, we tend to buy more stock; at the high end, we buy less.” The metrics are proprietary, he adds.

Still, says Ikenberry, it’s fair to say that last year the market had an overinflated view of stocks’ worth, influenced, no doubt, by what investors were willing to pay. On the other hand, Escherich says, “nobody buys high on purpose. And while some companies may not buy, because they believe their stock is overvalued, you’re never going to read about that. You only read about the buybacks that look ill- advised a year later.”

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For years, buybacks have seemed not only smart, but also routine. The theory goes, says Escherich, that whether one buys high or low, it all averages out. Some firms, for example, “are pretty steady buyers, paying both high prices and low. In effect, they are buying at average prices over time, never really making or losing money.” In addition, he says, buybacks have always been more than just a “buy when the price is low” strategy. Indeed, a recent study conducted by San Diego State University professors S.G. Badrinath and N. Varaiyat for the Financial Executives Research Foundation, cited five basic reasons to repurchase: to boost stock price, to rationalize the company’s capital structure, to substitute for cash dividends, to prevent dilution from stock option grants, and to give excess cash back to stockholders.

And despite recent market malaise, some finance executives believe those reasons are as valid as ever. At Cypress Semiconductor Corp., for example, CFO Manny Hernandez is very methodical about determining a market misprice, extrapolating it from the price-to-sales ratio. “We’ve been trending these metrics since 1986,” when the $1.3 billion San Jose, California-based technology- solutions firm went public, he says.

“Our mean ratio over this period (1986­98) is 2.23, meaning that 2.23 times sales is our market cap on average,” explains Hernandez. “Our P/S ratio in our 90th percentile band is 3.46, and in our 10th percentile band it’s 1.43. When our P/S falls below 2.23 and veers toward the 10th percentile, that indicates our stock is undervalued. That’s when we tend to buy it back.”

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