Buybacks, Cheap Debt and the Tech Bubble

 | Apr 24, 2014 | 4:00 PM EDT
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On Wednesday, I wrote about the potential for share buybacks either to prevent market crashes similar to those of 2000 and 2008-09 or to help ensure that a panic flight from equities would be short-lived.

Let's look at this issue a bit more broadly and deeply now. There is a great read on the subject of buybacks offered quarterly by FactSet. It's an easy read and I encourage everyone to check it out here. Standard and Poor's also commented on the issue in December. They contend that the correlation between share prices and shares outstanding is overly simplistic. It's also a good read.   

Having fallen 1.31% during regular trading hours Wednesday, Apple (AAPL) shares rose about 8% in after-hours trading following its announcement of better-than-expected quarterly earnings, plus an increase in the dividend, a 7-for-1 stock split and a $30 billion increase in its share buyback plan. That brought the total amount of money dedicated to buying back shares through 2015 to $90 billion. That's more than three times more than the approximately $27 billion Apple has already spent on buybacks in the past 12 months, which has already decreased outstanding shares by 5%.  Apple was already the number-one company for share buybacks.

Three more of the top 10 companies for share buybacks in the past 12 months are also in the information technology space: International Business Machines (IBM), Oracle (ORCL), and Cisco Systems (CSCO). Although Apple's buyback plan appears now to be a return of excess capital to shareholders, the buyback plans by the other three are a bit different and more to my point of cheap debt providing a safety net to stock prices.

Cisco raised $8 billion in the largest bond offering of 2014 in February, with the proceeds to be used to buy back shares. This is in addition to the $8 billion the company borrowed to buy back shares in the previous 12 months, even as revenue and earnings were declining and the stock price has been falling since last August. The serial buybacks have kept the share price propped up in a range between $20 and $26.

IBM spent $8.2 billion in the first quarter of 2014 on buybacks and even though it is not clear if this was debt-financed, it appears to be.  Like Cisco, IBM's buyback was explicitly designed to prop up earnings per share and the stock price, even as its revenue and earnings are declining and the company is trying to remake itself again. In the past 20 years, IBM has bought back half of its outstanding shares after suffering an existential crisis in the early 1990s. And this activity has largely been responsible for its price moving to the current price of $191.73 from a 1993 low of about $10.

Oracle has spent almost $11 billion, at least $3 billion of which was debt-financed, buying back shares in the past 12 months, even as its business slowed, helping to push the stock price to $40 from about $32.   

Many other large companies are doing the same: borrowing money to manipulate the number of shares outstanding, thus the price per share, to meet a target for earnings per share, even as real revenue and earnings are decelerating or even declining.

From a longer-term business perspective, this raises serious issues for investors. But immediately, as long as cheap debt capital is available, the ability to access it to prevent or even respond to an equity capital flight is there and will be used. That fact alone makes a replay of the 2000 meltdown much less likely. That doesn't mean that volatility will decrease or that deep corrections can't or won't happen; it only means that they will most probably be short-lived and, for all practical purposes, impossible for a retail investor to capitalize on.



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