Analyzing Share Repurchase Programs

By Allison Malkin

Recently I was asked to weigh in as a client decided whether to initiate a share repurchase program.  The client was contemplating a way to reduce future share price volatility following a revision to the company’s sales and net income guidance that caused their stock to decline by over 20% in a month.   Simply put, would the announcement and implementation of a share repurchase program demonstrate management’s and the Board’s confidence in their strategy and serve to reduce the severity of future stock price declines prompted by the publication of soft industry data going forward?

Over the past ten years I have seen share repurchase programs used successfully and have also seen companies buy back significant amounts of stock only to see their stock prices fall further, profitability fall and debt levels rise.  So to answer the question I pulled together a checklist to determine whether it made strategic sense and then shared three examples.
What is prompting the buyback?

Share price decline…

1. Does the company have a cash rich balance sheet that affords it to repurchase enough shares to alleviate downward pressure and at the same time invest in future growth? Then a share repurchase program is warranted.
2. Is the stock price decline indicative of a short term or longer term issue? If longer term, would the company be better served to invest in areas of the business that position it to improve its business model?
3. Has the company articulated their priorities for cash? Would a stock buyback be aligned with this ranking? For example, if priorities are to invest to drive future organic growth and utilize remaining cash flow for acquisitions, then announcing a buyback may signal that the company can’t find a compelling acquisition and call into question the sustainable long term growth rate causing further stock price compression.
4. Is the company reducing capital investment as it focuses on improving its business? If the company has a cash rich balance sheet and further investment is not needed to create the platform for sustained profitable growth a buyback is compelling.
5. Is the company being faced by activist shareholders that is pressuring it to repurchase shares? If so, see 1-4 above.
6. Is the company not facing downward stock pressure but has a cash position that will continue to rise despite investing in support of future growth… In the case where there is limited capital needed to drive long term growth then the board and management can go through the following checklist

Is a buyback preferred versus dividend?

1. Is a large percentage of the stock owned by insiders thus making a share repurchase program a more credible approach versus instituting a dividend?
2. Is the business cyclical? Could performance change that warranted stopping a repurchase program or cutting/eliminating a dividend?
3. How big of a dividend is needed to entice longer term income funds to invest?

For this client in question it was determined that they did not have the capacity to buy enough shares to alleviate the downward pressure in their share price and a share repurchase program was not aligned with articulated priorities for cash. That said, I thought it would be helpful to share the performance of three companies that implemented share repurchase programs.
Three examples from the retail industry:

COMPANY A: Positive result
This retailer articulated a target at the time of its IPO that NI was expected to grow by 20% per year.  This was mainly driven by operating income growth but supplemented with lower interest expense driven by debt pay down.  Following three years of achieving or exceeding this target and reducing debt to a level where the company felt further pay down was not warranted, the company then articulated that it had significant cash flow that enabled it to invest in future growth and at the same time repurchase shares.  The Company articulated this subtle change to focus on EPS growth versus NI growth at the time of its Q3 2015 call – well ahead of when it would give annual guidance for the following year. The share repurchase program was introduced at year end 2015 with the company’s share price up over 78% in the year following the program.  While the company invested $614 million to repurchase 9 million shares of stock from October 2015 through October 2017, its net debt/EBITDA declined to 1.8x from 2.8x.

Company B: Negative Result – could the company have utilized its cash to improve operations?
This retailer announced a share repurchase plan in March 2016 and continues to prioritize share repurchases today, as it focuses on turning around its operations.  A reduced share count drove EPS growth in the face of sales revisions throughout 2017.  In fact, in 2017 sales and adjusted EBITDA declined slightly with adjusted EPS up 4.7% driven by the repurchase of 16.4 million shares in the year.  From March 2016 through March 2018 the company repurchased 28 million shares with a value of $606 million with its shares declining 49% during this same time period.  Net Debt/EBITDA remained fairly constant at 2.77x at the start of the significant repurchase activity to 2.9x at March 29, 2018.

Company C: Negative result – Would have been better served not repurchasing shares as business conditions softened
This retailer began a share repurchase program in 2010 with positive results having gone through a study and determined that it would have significant cash flow even after investment in organic growth and acquisitions with share repurchase prioritized over dividends given the large holdings by the CEO.  Business trends changed in 2013 yet the repurchase activity continued with 10 million shares repurchased for a value over $1 billion dollars from 9/30/13 through 9/30/16.  The company’s share price at the start of the buyback was $116 and at the end of the buyback was $28 with Net Debt/EBITDA rising to 1 from 0.3x.