Wednesday, November 21, 2007

Attention Target Management: Pay No Attention To Analysts Begging for Buybacks



Big Buybacks Begin to Haunt Firms
More Cash on Hand Might Have Protected Freddie, Fannie Shares
—By GREGORY ZUCKERMAN, KAREN RICHARDSON and JUSTIN LAHART



Driven by billions of dollars in share buybacks, record-setting buyouts and a wave of mergers, the amount of stock in the market shrank by hundreds of billions of dollars in the past four years.

With the supply of stock down and demand strong, the market rallied. Now, as the economy slows and credit markets buckle, high-profile companies are cutting back on buybacks, and some wish they held on to the cash they gave back to shareholders.

—Wall Street Journal, November 21, 2007


So says today’s Wall Street Journal, although this is not news to readers here at NotMakingThisUp (see “The Shareholder Letter You Should, But Won’t, Be Reading Next Spring” from August 8, 2007.

Nevertheless, lest anyone think the Journal is making much ado out of nothing, I would say the Journal goes too easy on those Captains of Industry who chose to pump up their stocks for short-term gain and fleeting kudos from Wall Street’s very fickle Finest.

After all, today’s story politely leaves out one of the all-time great admissions of regret—ranking right up there with Chamberlain after Munich, business-wise—which came yesterday morning from one of the most aggressive practitioners of the “return value to shareholders” school of balance sheet destruction: Steve Odland, the CEO of Office Depot.

A sober Mr. Odland, formerly hailed as the savior of that once-proud office products retailer following a highly successful stint spent largely buying back stock and occasionally running stores at AutoZone, told Wall Street’s Finest:

We are very disappointed in our third-quarter results and remain concerned about the economic environment over the next few quarters. We are also very unhappy with our stock price.

Unfortunately, we have cleared the balance sheet of cash, and our operating cash flows declined, so we don't have the opportunity to buy back shares at a time when we believe they are a huge value. [Emphasis added.]



Specifically, Office Depot “cleared the balance sheet” of $200 million this fiscal year by buying 5.7 million shares at $35 a share.

While that doesn’t sound like much, it came after “clearing the balance sheet” of $971 million in fiscal 2006 by buying 26 million shares at an average price of $37 per share. (Last trade--you don't wanna know.)

Where this leaves Office Depot as a stock, we express no opinion, but management at Target ought to think twice about listening to the barking seals otherwise known as Wall Street’s Finest—the analysts who applaud companies such as Office Depot for giving short-term oriented shareholders short-term rewards such as high-priced stock buybacks without any notion of the kind of painful long-term consequences now being suffered by Office Depot’s shareholders:

Nov. 20 (Bloomberg) -- Target Corp., the second-largest U.S. discount chain, posted an unexpected decline in quarterly profit after consumers facing higher mortgage payments and gasoline expenses cut spending. The retailer also said today it will buy as much as $10 billion of its stock, which lost almost a quarter of its value since reaching a record in July….

``It's the right thing to do to leverage up their balance sheet and buy back stock in the face of slowing overall sales growth,'' [emphasis added] said Jeffrey Klinefelter, an analyst at Piper JaffrayCos. in Minneapolis, who recommends investors hold their shares.


I’d like to see Mr. Klinefelter tell that to a room full of Office Depot shareholders, and get out alive, or, at the very least, with his flippers still attached.

Our metaphorical hat goes off to the Wall Street Journal for flagging a timely and important topic...but how they left out the best part of the Office Depot call is beyond us.


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 investment advice, nor is it a solicitation of business in any way. It is intended solely for the entertainment of the reader, and the author.

12 comments:

Tianming said...

Jeff,

I disagree with your opinion. Stock buyback should be done if price paid is less than the intrinsic value. If that's the case, even though the stock price can furthur drop dramatically after your buyback, it's still a smart thing to do. No one knows how the stock market is going to do; you should do what's good at the moment.

I have no comment whether ODP or target should buyback though as I have no idea what their IVs are.

-tim

Harleydog said...

Jeff

As usual another great post on a subject I(among others)have been critical of for some time.

Good trading to you and enjoy your Thanksgiving holiday.

Len said...

Jeff,
I think you're right on the money.
As a shareholder who's taking the hit, I wonder how much better off Citigroup shareholders would be today if the former management and current board had planned for the "worst case" out come and sat on some of the cash they used to buy back all the shares they did over the last couple of years.
If your holdings in the stock decline by 10%, does it feel the same to the guy who starts at $100 million in the stock as it does to the guy who starts with $1 million in the stock?

Bud said...

Stock buybacks may well work for some companies with sound cash flow and the room for more leverage. However, I think we are now seeing the impact of leverage coming back to bite companies, especially financials, that must raise more equity to support their flawed investment decisions.

Good work as always, Jeff. Regards, Old Native

David said...

Jeff,

I gotta think that you're kidding here. I'm gonna echo tim - don't you think share buybacks are good at a certain price (less than intrinsic value) and bad at a certain price (more than intrinsic value). I've got no opinion on ODP, but would you say Eddie Lampert is a jackass for buying back SHLD shares at 150 just b/c the stock is at 110 now? What if its RE value really is close to $1000/share as Bill Ackman has hinted. What is it's only a quarter of that? Would share buybacks be the right move? I'm surprised about this one from you, 6 months of stock performance doesn't prove anything...

smithycroftman said...

Tim and David,

I've got to side with Jeff on this one. Tim you say no one knows what the stock market will do but working out Intrinsic Value is a mighty hard thing to pin down too. Management should be held to account for how they reinvest cash flow, if they waste it on takeovers hold them accountable, if they buy their stock and it halves again they should be held responsible, we shouldn't just nod and say whither the stock market. I don't hear too many people telling Uncle Warren to gear up and buy back Berkshire stock, but seeing as his total comp isn't boosted by some nice little, or not so little, options package, I doubt he'd listen anyway.

Sam E. Antar said...

To all CEO's and CFO's:

Never have your company buy back stock while your company commits fraud.

Never personally buy your company's stock while if you are committing fraud.

I did both.

Those so-called confidence building measures don't work in the run long.

They will come came to haunt you.

I am not making this up!

Respectfully,

Sam E. Antar (former Crazy Eddie CFO & convicted felon)

Invictus said...

Just goes to show how terrible a medium-term forecast stock buybacks tend to be. Long-run ODP & the plethora of other companies may will be right, but using stock buybacks as a guide to anything but short-term stock price floors is just silly.

Now the question is with much of corporate stock repurchasing buying power diminished and the credit markets hesitance to provide the capital to loan companies for more stock-buybacks, and diminished leverage by quant and hedge funds, and private equity where is the new floor for stock prices?

Jeff Matthews said...

Tim and David misconstrue the point. The point is that buying stock back for the sake of buying stock is stupid, pointless, and good only for the investment bankers.

But they do raise a good one of their own: there's no reason management shouldn't buy stock back when it represents true value.

Bob Shaw did it in 1990, as I pointed out in the Buffett series, when Wall Street would have nothing to do with carpet stocks. He was dead right, and created tremendous value for Shaw shareholders.

And yes, Eddie Lampert bought Sears when it was misunderstood and roundly hated. He saw value and was proven right.

But neither Eddie or Bob was buying for the sake of getting rid of cash. They were buying cheap. They weren't doing simply "what's good at the moment," in Tim's words: they were doing what they knew would be good in the long run.

What ODP, Home Depot, Scott's Miracle-Gro, Dean Foods and others have done is the opposite: they bought stock at demonstrably high prices simply to rid the balance sheet of cash supposedly to "enhance shareholder value" at a time when the Dow Jones Industrial Average was at or near its all-time ever record.

They were not taking advantage of a market crash or an earnings-miss related stock drop. They were buying momentum.

Think about that: it is the opposite of smart. It is dumb. It is buying high...so that they do not have the ability to buy low.

Some smart academic is going to have a field day computing how much value management teams have destroyed "enhancing shareholder value."

Andy Tabbo said...

Stock buybacks are a ridiculous use of cash by management. If managment feels compelled to return cash to shareholders, they should do it with dividends. Period. End of story. With today's tax treatment on dividends, there should be no other option than a dividend. For a management team to buy back it's own shares, they must make the following assertion: Our stock is the best asset to buy in the entire world! Let the shareholders decide how the excess cash should be spent. If shareholders feel that the stock is the best asset to buy in the whole world, then the shareholders will buy more stock with the dividend.

120wallace said...

I think you may want to add DPZ to the list of managements that burned through cash. Although they did the special dividend they are now being impacted by the increases in commidities and a slow down in spending.

Aaron said...

"Stock buybacks are a ridiculous use of cash by management."

Respectfully, I strongly disagree with this statement. Only recently has the tax treatment on cash dividends changed to the point where the tax-rate on dividend income is similar to that of capital gains from stock buybacks.

When companies initiate stock buybacks, however, there are many more benefits than paying cash dividends. Stock buybacks, when done at the right price, can reduce outstanding shares, raising the value of exisiting shares and options. In addition, retained earnings should, in theory, rise if sales and earnings remain the same.

Cash dividends are income which is double taxed, once at the corporate level and again at the personal level. Stock buybacks generally get better tax treatment and, thus, are a better use of company cash, but only if the buyback is done at the right price.

Dividends have always been a "signal" to investors that the "growth story" in earnings is over and that there is no better use for cash to either buy back stock or improve its operational efficiencies.

One other company you can add to the stock buyback list is TGT's competitor, WMT. Is it me or is WMT issuing a lot of commercial paper recently to pay down exisiting long term debt, and issuing more long-term debt to fund both its stock buybacks and its dividend increases?

I recently noticed that WMT's been buying back stock at an average price of about $47-$48 per share and the share price is "hanging around" the same price range today.

Two questions immediately come to mind about WMT and its stock buyback program:

A) Are stock buybacks better when done with debt as opposed to being internally funded (i.e., from existing cash flow) when done at the right price?

B)What factors would cause a company to use commercial paper from cash flow for financing operations (i.e., GE)?

Just curious...