Share Repurchase - To Buy or No to Buy

Introduction
Ø 39% of the respondents → instituted a share repurchase program → in order to improve their earnings per share numbers
Ø 28% → their companies were using buybacks as a way to distribute excess cash to shareholders
Ø 21% → reported that their companies were trying to reduce the cost of employee stock option plans
Ø 12% → adjusting capital structure was the main reason for their stock buybacks
Ø This research mission → to determine the long-term effect of stock buyback program on the company’s stock price and to access which companies benefit most from this program

Why repurchase shares?
Ø First → to increase share price → when the company’s stock undervalued by market analysis
Ø Second → to rationalize the company’s capital structure → allows the company to sustain a higher debt-equity ratio
Ø Third → to substitute share repurchase for cash dividend payouts → since capital gains may be taxed at lower rates than dividend income → a share repurchase program offers long term shareholders some major tax advantage
Ø Fourth → to prevent dilution of earnings → share repurchases can enhance a company’s growth in earnings per share → conversely prevent an EPS decrease that may be caused by exercises of stock option grants
Ø Fifth → to deploy excess cash flow → stock buybacks can be attractive alternative investment for any cash flow left over → once the company has meet its capital investment need
Ø Company that want to repurchase shares has several different options
o Conduct open market repurchases
o Tender offers → both fixed-price and Dutch auction
o Privately negotiated repurchases

Four Key Findings
Ø First → Shares Outstanding → although the company repurchase majority of its shares → there were still a small proportion of the total shares outstanding abaout 5%
Ø Second → no subtitle for dividend payouts → companies don’t seem to be using share repurchases as a substitute for dividend payments to shareholders → although the dividend payments have smaller amount than the buyback shares → the dividend payout ratios increase once the stock buyback program is over
Ø Third → Effect on Earnings Per Share → after the repurchase program → there is a significant increase in EPS growth → although not as big as company that do not repurchase stocks → so repurchasing firms are effectively closing the gap between their EPS growth rates with their industry peer that aren’t buy back stock
Ø Finally → Effect on Debt → increased by a modest amount for the sample → even though 27% of the funds used to repurchases stocks are come from theexcess operational cash flow

Guidelines for Getting Going
Ø If company considering a stock repurchase plan → CFO have to wonder whether this program really will rev-up company’s EPS growth?
Ø As general guidelines: Companies repurchase equity only under these two circumstances
o When they have excess debt capacity and → the supply of funds exceeds the demand
o When they’re underperforming in terms of → profitability and sales growth rates relative to their industry’s average
Ø Companies should avoid stock buybacks under these two circumstances
o When they’re over-leveraged and sales growth rates excess industry averages
o When both their profitability and sales growth rates excess industry average
Ø Stock buybacks also have regulations
o Volume limit on repurchases and contains a host of other procedural requirements
o Company cannot conduct a share repurchase program at the same time → it is engaging in a securities offering
o Cannot allow buybacks to exceed one quarter of the trading volume of the stock for the prior 30 days

The Value Connection
Ø Shareholder Value Based Management (SVBM) Framework → demonstrates that long-term shareholder value → created by the firm’s growth and profitability prospects from its product market positions
Ø Share repurchase program can either create or destroy value → depend on how they affect investor’s perceptions → about the firm’s long-term prospects
Ø Without a clearly expressed rationale → the company’s decision to conduct a repurchase program could be misinterpreted by investors → as a negative signal
Ø Financial executives must start their decision making by evaluating the demand for investment funds → as determined by the availability of investment opportunities
Ø Also supply of invest-able funds → determined primarily by the company’s profitability
Ø Conclusion → developing and implementing a share repurchase program is no simple task
Ø To conduct a successful buyback → must figure out how to bring the two major aspect of the job → Strategy and Finance → together in the most effective way possible