Large companies like Meta attempt to please shareholders with substantial dividend payouts and share buy-backs
What is this about corporate stock buy-backs? Why do they occur? Why do some of the loudest shareholders push for both dividends and occasional repurchases of shares? Some of the best known global companies and even some not as known occasionally plan buy-backs. Some buy back shares routinely.
They go into the marketplace and use excess cash reserves to buy back their own shares. They do so at discretion. The cash could have been used to invest in new businesses or to pay down debt.
Sometimes they do it if managers perceive their share values are under-valued. Buying back shares will likely provide a short-term upturn in the stock price (as supply of shares declines). The evidence shows the occasional "boost" to share value once a repurchase is announced. Companies that pay consistent and growing dividends get a boost in share value. Shareholders see greater value of cash in their hands of shareholders than in cash sitting idle of a balance sheet.
Thriving, well-established companies (even many banks and large financial institutions) report growing earnings and operational cash flows. As cash builds on the balance sheet, they face potential pressure from active shareholders, who inquire: "At what point do you give that cash to us?"
Old corporate finance texts contend shareholders have an expected return on investment (cost of equity).
If the company has excess cash, instead of allowing the company to maintain it in reserves or even hold it in a foreign subsidiary (often the case), shareholders argue if the company can't or doesn't reinvest at a required rate of return, then the cash should be returned to shareholders. They, in turn, can find other channels or opportunities to invest at the expected return.
But insteady of sending out cash already on the balance sheet, what happens if management elects to go out into debt markets and borrow substantial amounts and use that cash to conduct buy-backs (or pay increasing amounts of dividends)? How does management justify leverage for that purpose? Why would shareholders encourage more debt for this specific purpose?
Note the substantial buy-backs some prominent companies engaged in over the past several years: Merck bought back over $17 billion in shares from 2017-19, some of it financed by borrowing in low-rate markets during the period.
PepsiCo repurchased $18 billion in shares from 2017-20, similarly funded in part by low-rate debt. Coca-Cola, PepsiCo's long-time competition, bought backs shares, also at substantial levels. As rates started to rise in 2022, the same companies reduced their buy-back programs to avoid using more expensive debt to fund this activity.
With plausible scenarios of rates falling in late 2024, buy-back popularity has resumed. In 2024, Meta announced a $50 billion buy-back and new plans to pay dividends for the first time. In little time, its stock price leaped 14% just from the announcement.
Such buy-backs for these and other large familiar companies, in many cases, helped to increase share values for mature companies with large slices of their product markets, but low growth in revenues and earnings. Higher leverage and fewer shares outstanding kept stock prices from plummeting when there are few signs of growth. The stock price holds tight even when expectations for revenue growth fall below 5% per annum.
When prospects for growth dim and threaten to undermine the intrinsic value of the shares traded, a buy-back program might be able to keep share prices from sliding.
Merck and PepsiCo have long been regarded as mature, low-growth companies. Perhaps Meta has joined the mature-company club that includes older companies with their best days of soaring revenue growth behind them. Meta retains market share, continues to be predictably profitable, but growth rates are not what they had been 15 years ago, and shareholders covet the cash resting on the balance sheet.
If a company's performance, operating cash flow, and prospects for growth are excellent, steady and vivid, then the increased leverage might be rationalized comfortably. What, however, if performance is erratic or the company is headed into risky, recessionary scenarios? How would excess leverage justified?
(In the world of private companies, management-owners might consider "dividend recaps," or dividend recapitalizations, where the company borrows in debt markets and uses the proceeds not for growth and expansion, but to reward private owners with dividends that may not have been paid before and may not be justifiable from earnings. Private owners (sometimes founders) argue this is a way to monetize the efforts they expended to found a company or manage an operation.)
When it comes to shareholder expectations, banks address the same. When banks have exceptional earnings and start to accumulate excess capital (excess beyond what regulators require), they, too, seek to give it back: increase dividends or conduct buy-backs.
For banks, the story takes a different turn during periods of uncertainty or distress. Regulators around the globe reserve the right to intervene and discourage banks from conducting buy-backs. During the financial crisis and during the early months of the pandemic, 2020, bank supervisors (including the Federal Reserve) swiftly adopted rules (at least for a defined period) to suspend or cancel buy-back programs. Bank regulators, of course, focus on financial institutions having more than adequate amounts of equity to absorb losses during stress and avert the likelihood of deposit run-offs.
Lenders and debt investors who fund these corporate rewards or maneuvers must get comfortable with such use of cash. Investment-grade companies have power to convince debt markets that increased leverage won't harm performance (and undermine the ability of the company to meet debt requirements). Yet leverage will increase. The Debt/EBITDA ratio might rise--almost, in certain cases, to levels that suggest greater risks or non-investment-grade considerations.
Some may contend buy-back programs and using leverage to boost returns and share price are forms of "financial engineering." Unless the company is a regulated financial institution (including also broker/dealers and insurance companies), markets and investors become the factions that "regulate" whether such activities harm creditworthiness or financial condition.
If the company is a public company, could it also be considering doing the buy-back to take it private? Or does management or a private fund want to gain complete control of the enterprise (something that happened at Dell Computer in 2013).
In some cases, companies conduct buy-backs if they don't pay dividends or if they prefer shareholders not get accustomed to regular dividend payouts. They still want to be responsive to shareholders who request immmediate rewards. The technology firm Synopsys in Silicon Valley has done just that in recent years.
Its performance has been excellent and consistent (stable returns on capital, steady revenue growth leading to steady earnings increases), but the company has not paid dividends. Earnings pile up in cash reserves, which help fund many small acquisitions that complement current business strategy.
Synopsys revenues will likely top $6 billion this year, and earnings have begun to exceed $1 billion annually. Its shareholders have pushed for "rewards" in some way (to help boost share values), and the company has obliged by paying out over $2.5 billion for share buy-backs the past three years.
Tracy Williams
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