December 28, 2015

More on “Buybacks: Still In the News”

Recently, I blogged about the continued criticism of stock repurchase programs. In response, I received this note from Downey Brand’s Bruce Dravis:

Thanks for flagging new articles on the share buybacks. The main point of the Reuters piece tracks ground covered by a Harvard Business Review article last year on how the combined dividends and buybacks exceeded earnings over a given period. However, earnings, dividends and share buybacks are very different operational events for a company. While dividends and buybacks both involve expenditures of cash, they represent divergent strategies for providing returns to shareholders.

Conflating them in order to see if the combination exceeds company earnings generates an interesting number—but shouldn’t generate an automatic conclusion that shareholder payments are crowding out capital allocations for company development. It’s true that companies are under pressure from some activists to deliver short-term results. There is also a countervailing pressure from institutional investors to deliver sustainable results, which requires strategic investment.

Measured in absolute dollars, the amount spent on stock repurchases is a big number. A fairer picture, though, should include looking at how much the share repurchase expenditure is offset by the cash companies take in through equity compensation plans.

For example, I looked at Intel from 2006-13. Over those eight years, the company issued roughly 850m shares in equity compensation, taking in roughly $12.5b in cash and tax benefits. The issuances, by themselves, would have diluted shareholders by about 15% from the Jan. 1, 2006 starting point. In the same period, Intel repurchased 1.8b shares, for about $40b. Netting the equity plan issuances against the repurchases, you find about $27.5b in net cash expenditures to generate at net anti-dilutive impact of about 20% compared to the Jan. 1, 2006 starting point (in other words, the company bought back all the dilutive equity compensation shares, plus a lot more).

Since equity issuances and repurchases are both capital transactions, I think this comparison is more apt—or at least, adds to creating a more complete picture — than a comparison to earnings alone. If you also consider equity issued for acquisitions — arguably an investment in growing company revenues, albeit not made in R&D dollars — you get an even more complex picture than is suggested by the “Earnings=Dividends+Buybacks” formula.

Here’s a response that I got to Bruce’s note:

Perhaps Bruce should look at the whether the companies with buybacks are granting stock options instead of restricted stock! I gather that most stock based compensation is in the form of the latter. Besides, having buybacks that are tied to stock options means the company is buying shares when employees are selling, instead of making an independent capital allocation decision, and his comment has positive connotation – so just wanted to point this out.

In addition, here’s a Bloomberg piece with a countervailing view about the pace of buybacks…

Nasdaq’s Proposal: Regain Compliance Before Delisting for Failure to Hold Annual Meeting

As noted in this blog by Steve Quinlivan, Nasdaq has proposed to have the discretion to grant listed companies an extension to regain compliance before delisting a company that fails to hold an annual meeting. In determining whether to grant a company an extension to comply with the annual meeting requirement, Nasdaq will consider the likelihood that the company would be able to hold an annual meeting within the exception period, the company’s past compliance history, the reasons for the failure to timely hold an annual meeting, corporate events that may occur within the exception period, the company’s general financial status, and the company’s disclosures to the market.

What is “Private Ordering”?

Here’s an excerpt from this blog by “The Activist Investor” to explain a concept that wasn’t familiar to securities lawyers a decade ago:

It refers to a long-standing legal concept in which individual parties agree on how to police an activity, instead of relying on government regulation. It can apply to all sorts of activities – for example, development of information technology and the Internet, and the rules for standardizing structures and processes in online affairs.

To activist investors, it refers to how shareholders agree, with each other and with company management, on how corp gov will work at a given portfolio company. They do so instead of relying on states, Congress, and the SEC to prescribe corp gov principles as law and regulation.

This is different than self-regulation. When an industry self-regulates, it promulgates its own standard rules that apply to all parties (companies, consumers). Private ordering defines specific rules for each individual situation, in this case each individual company.

In the corp gov world, private ordering can apply to just about any part of company bylaws. Most recently, bylaw provisions for forum selection and litigation costs have stoked the debate about whether state corporate law and regulation or agreement among shareholders and management should prevail.

It also applies to the debate over proxy access, among other areas that fall within Federal jurisdiction. Recall how proxy access started as a strict SEC regulation requiring access on specific terms, pursuant to the Dodd-Frank Act. The SEC also allowed shareholders to propose different proxy access terms, in a bylaw amendment or non-binding resolution. A friendly judge vacated the regulations, but let stand the part that allowed shareholders to propose some form of proxy access for that company.

We note that regulation and private ordering sit at the two ends of a continuum of choices, rather than as the only two choices. We (the investing public) can decide to regulate something that won’t work for private ordering. We can leave to private ordering something else that is too expensive or complicated to regulate. We can regulate lightly, and leave some elements of a subject to private ordering. The possibilities are endless.

Broc Romanek