In the rush to stop many of America’s largest businesses in the travel, aerospace and entertainment sectors from going bust during the coronavirus crisis, many commentators have pointed out that a few short months ago, these same companies were buying back their stock hand over fist.
The latest example is a CNN article Tuesday:
Corporate America, armed with the Trump tax cuts, lavished Wall Street with a multi-trillion dollar share buyback spree over the past two years.
Now, some of the same companies that binged on buybacks are in line to receive taxpayer-funded bailouts to keep them alive. Boeing, for example, spent $11.7 billion over the past two years on repurchasing stock before suspending buybacks in April 2019 because of the 737 Max crisis. The aerospace behemoth is now requesting $60 billion in federal assistance as the coronavirus crisis has crushed its customers and forced factories to shut down.
The criticism stems from the idea that instead of returning cash to shareholders, businesses should have saved for a rainy day, or a global health crisis when demand goes to zero. Apart from the fact that those $11.7bn of Boeing buybacks wouldn’t cover two years of operating expenses during a normal business environment, we do feel like that such arguments are not seeing the wood from the trees.
First off, Alphaville is not here to pass judgement on the practice of share buybacks. Many before us, including former Alphavillain Dan McCrum, have done a good job of that.
Instead we want to make the simple point that modern management culture dictates the following: if you have excess cash on your balance sheet, and no investment projects to pursue which promise a return on capital greater than your cost of capital (both flimsy ideas in themselves, but no judgement), then you should return the cash to shareholders who can deploy it elsewhere.
The issue here is what happens if a chief executive decides to go against the grain.
Let’s take an example. Company X is a successful American corporate with $10bn of cash on its balance sheet, that generates $2bn of cash flow from operations per year. Long-term shareholders in the business have been richly rewarded, both with explosive capital gains and smaller dividends and buybacks (c$700m worth per year, let’s say) over the past decade. On top of its core business of selling overpriced widgets, it is using some of this cash to pursue new product ideas that may not pay-off in the short term. However, as its last widget was such a smash hit, investors are giving it a wide berth.
There’s a problem though: a Harvard Business School-trained hedge-fund manager – Michael Ben Amos – believes Company X should be doing a lot more for shareholders right now. So his $5bn fund takes a 5 per cent stake, and starts agitating the board for more of that cash pile to be returned to shareholders. He proposes several ideas: a larger buyback, a new preferred stock paying a larger dividend, or a one-off special divi. If not, he’ll pursue board seats, make legal threats, and generally make the company’s management extremely uncomfortable.
The chief executive refuses to play ball. The conflict escalates. Euphemistically worded legal letters are exchanged. Proxies are filed, and Mr Amos’ new shareholder return plan is taken to a shareholder vote. After a furious few months of lobbying, Mr Amos wins out. He takes three board seats, Company X’s chief executive resigns, and the shareholders are rewarded with a mega buy-back programme. The development of the risky, long-term product is cancelled, with smaller, incremental, bets placed instead.
If this sounds like a company you follow, it’s not because we’re masking names. It’s because it’s such a common occurrence. The message from the markets over the past decade has been clear to parsimonious management without the safety net of a controlling stake: aggressively reward your shareholders, or else. Projects without a clear path to higher returns? Can them. We know better.
It’s not an indictment of the system, that’s just how it is. If Congress, or other governments, want to make their national businesses more resilient to downturns in the future, then the changes required are fundamentally cultural. Given how Western investors have long-scoffed at Japanese corporates with gigantic cash piles, FT Alphaville reckon such a shift will take a decade, if not a generation and will require wholesale changes to both to the law and academic theory. That’s assuming, of course, the political classes think it’s a good idea, which they have plenty of incentives not to.
But then again, even if a new corporate culture of piggybanking profits was somehow instilled, what businesses are resilient enough to survive their revenues going to zero in the space of one month for a period perhaps as long as a year? We’d venture: none.
As much as some would like to believe the coronavirus pandemic has revealed a corporate governance problem that we somehow were not aware of before, it hasn’t. So let’s stop treating it like one, even if it is good politics.
Get alerts on Share buybacks when a new story is published