Wednesday, August 08, 2007

The Shareholder Letter You Should, But Won’t, Be Reading Next Spring

Dear Shareholder:

Well, it seemed like a good idea at the time.

I am referring to your board’s decision to approve a massive share buyback and huge special dividend last summer, when the buzzwords going around Wall Street were “returning value to shareholders.”

Why we did it was this: a smart banker from Goldman Lehman Lynch & Sachs came in, all gussied up and looking sharp, and made a terrific PowerPoint presentation to the board with multi-colored slides that showed how paying a special $10 a share dividend, plus buying back a bunch of our stock at the 52-week high, would “return value to our shareholders.”

We should have thrown the fellow out the window, along with his PowerPoint slides, but what happened was, my fellow board members and I were so busy deleting emails from our Blackberries that we just didn’t notice the last slide showing (in very tiny numbers) the “Trump-style” debt we would be incurring to do so.

We also missed the footnote showing the fees that would go to Goldman Lehman Lynch & Sachs for the courtesy of their showing us how to wreck our balance sheet.

Those fees, I am embarrassed to say, amounted to more money than we made the quarter before we “returned value to shareholders.”

But the fact is, we’d been getting so much pressure over the last few years from the hedge fund fellows who own our stock for ten minutes tops, not to mention the so-called “analysts” on Wall Street (around here we call them "Barking Seals"), to do something with the cash...well, the truth is we just couldn’t stand answering our phones any more.

So, in order to finally start getting things done instead of spending all day explaining to these hedge fund fellows and the Barking Seals on Wall Street why we weren’t “returning value to shareholders,” we decided to do the big buyback and the big dividend.

And for a few weeks there, it was pretty nice.

The stock jumped, the phones stopped ringing, and the Barking Seals started congratulating us on the conference calls instead of asking us when we were going to get rid of our cash.

Unfortunately, not only did getting rid of our cash and taking on a huge debt load NOT “return value” to you, our shareholders, it actually crippled the company for years to come.

For starters, as you know, the aftermath of last summer’s sub-prime debt crisis is forcing perfectly fine companies to liquidate businesses at fire-sale prices…but we can’t take advantage of those prices, because we have no cash. And thanks to the debt we incurred “returning value to shareholders,” the banks won’t loan us another dime.

Secondly, as you also know, we’ve had to lay off hundreds of loyal, hard working employees to pay the interest expense and principal on all that debt, because unlike Donald Trump, we actually repay our debts.

Furthermore, as you probably don’t know, we’ve also scaled back some interesting research projects that had great long-term potential for the company, but were deemed too expensive to continue in light of the fact that we have no cash.

Now, I’d feel a heck of a lot worse about all this if we were the only company suckered into buying our stock at a record high price and paying a big fat dividend on top of it.

But I’m happy to report there were others who also did the same stupid thing.

For example, Cracker Barrel, the restaurant chain that depends on people having enough money for gas to get to its stores along Interstates across America, spent 46 bucks a share for 5.4 million shares of its stock early last year to “return value to shareholders.”

Cracker Barrel’s stock now trades at $39.

And Scott’s Miracle-Gro, whose business is so seasonal it loses money two quarters out of four, put over a billion dollars of debt on its books with the kind of special dividend and share buyback we did.

Health Management Associates—a healthcare chain that can’t collect money from about a quarter of the patients it handles—paid shareholders ten bucks a share in a special dividend to “return value to shareholders” and then missed its very next earnings report because of all those unpaid bills and all that new interest expense it was paying.

Oh, and Dean Foods, a commodity dairy processor with 2% profit margins, returned all sorts of value to shareholders early last year—almost $2 billion worth—just before its business went to hell in a hand basket when raw milk prices soared.

So, you see, everybody was doing it.

And boy, do I wish we hadn’t.

Jeff Matthews
I Am Not Making This Up

© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


jmf said...

BRAVO from Germany!

pondering said...

Isn't there a worn out metaphor that covers this? I think it has been updated recently to include especially well educated MBA's. I think it went...fools and their money. This is why Buffet remains such a fascinating data point.

Stevo said...

You were shur right about Dean Foods. It has got to have the dumbest management in the World (or they are pretty clever and filling their own pockets at the expence of thier shareholders) The big payout dividend and subsequent addition of expensive debt don't make a lot of sense. Dean could go down the milk hole again.

whydibuy said...

Well, its the quick & easy way to bump up the share price, put your stock options in the green and cash in without actually doing any nuts and bolts drudgery of running a business. Its financial alchemy. It works like magic in the short term....and thats all your really worried about anyway. You can't blame 'em. They're just following the governments example of please 'em now and let someone else worry about the consequences further down the road.

buckeye1 said...

Barking seals reference is absolutely hilarious. I plan to use that phrase often.

BelowTheCrowd said...

I think you got the investment bank name wrong. Wasn't it actually Morgan Lehman Lynch & Sachs?

(I mean, just to be fair...)


Chris Fischer said...

I agree with some of the posters here. You'd be exactly right in the hindsight sentiment of management, assuming management was really interested in the long term health of their enterprise instead of lining their own pockets now.

This reminds of when Blockbuster paid out the same kind of special dividend ($5/share, which was pared back from a $8/share dividend that Wall St. wanted) financed by 1.2 billion of so between $300M of new notes issued and a credit line for rest. From an operational standpoint, that seemed very questionable, given that Blockbuster was fighting lots of new competition (Netflix, etc.), revenues were declining and it wasn't exactly raking in cash.

However, since Viacom held a 80% and was spinning it off, to me it just looked like Viacom selling off a large percentage of its stake, taking the cash and running.

Look at what BBI has done since.

My question is, what kind of bank is foolish enough to lend them that money (at a rate of something like LIBOR + 1% or so) especially onsidering that the $300 million of notes issued held a 9% interest rate (in 2004, when short term rates were around 1% and long term was around 4%.)

Scott said...

Great posting! We all loved it at Steadyhand.

Scott R.
Steadyhand Investment Funds

Anonymous said...


I have to disagree somewhat with your characterization that stock buybacks when funded with debt offerings are necessarily a "bad" thing for shareholders.

One benefit when using debt to fund a stock buyback is that the interest expense paid on such debt is usually tax deductible which, in theory, should add back to earnings in the form of lower tax outlays.

In addition, corporations add call features to bonds so that, in light of interest rates falling, those bonds can be retired at below market prices, reducing interest expense (I could be wrong on both points here).

One of the key questions regarding stock buybacks is, what is management's motiviation for doing so? Is the objective simply to increase all shareholder value or, more likely, to increase the value of option holders such as corporate executives at the expense of non-employee shareholders?

I included an academic study here so your readers can see what I am referring to.

Interesting post which deserves further exploration.

Jeff Matthews said...

Aaron: I actually didn't mean to characterize debt-funded share buybacks as "bad."

In fact, when done at intelligent prices, for intelligent reasons, they are quite good.

I could name a dozen that have added great value to shareholders if I thought about it. (Washington Post is a case study in successful, value-added buybacks).

What they would all have in common is this: they were done at times of depressed valuation, when the stock market wasn't valuing the business correctly in the board's eyes.

The buybacks I'm specifically criticizing are those done a peak prices, where the economics are questionable even if, theoretically, they add a penny or two to earnings...all for the sake of a meaningless mantra.

And you should add Expedia to the list--they could have bought their stock at $15 a year ago, but they waited a year and decided it was better to pay double that price. Why? Ask Barry. And the bankers.


Z said...

In financial theory, a share buyback indicates that the company has no other comparable investment alternatives. In other words, they don't have any new products they can introduce, improvement projects that can undertake, companies they can purchase, marketing campaigns they can produce, etc. Wall Street has spun share buybacks and returning cash to shareholders into something positive, but it really is an admission of defeat.
- Tristan Yates, IndexRoll