Monday, August 17, 2009
The Opportunity Cost of Thinking like Everyone Else
Back in the day—that would be nine months ago—when the once-bright world had gone dark for millions of home-flipping Americans and second-property-in-Spain-buying Brits, one significant repercussion of the housing collapse was being felt on American stock exchanges: corporate treasurers at literally hundreds of publicly-held companies who had once thought nothing of paying irrational premiums for their own shares in the name of Returning Value to Shareholders were suddenly watching those same share prices flicker by on their computer screen at half or more off the price they’d willingly paid with all the abandon of an Inland Empire home buyer not many months before.
And the reaction of those corporate treasuries was—like the Inland Empire home owner suddenly underwater on their mortgage—to freeze.
We pointed out one such example, a specialty chemical maker called Lubrizol that had purchased its own stock at $52.63 a share during the September 2008 quarter, but refused to touch the stock when it was being offered, in size, in the vicinity of $37 a share one month later, as we pointed out in a virtual column called “Companies Bought High, But Won’t Buy Low” (November 3, 2008).
At the time, Lubrizol’s Treasurer, Charlie Cooley, explained the strange logic behind the company’s “Buy High, Don’t Buy Low” repurchase strategy as follows:
Fair question….we have been asked this question during the course of the year, asking why our share repurchase program has been as kind of methodical and systematic as it has been.
We have never viewed the share repurchase program as primarily being a tool of making a call on our share price. Rather we see it as a way of balancing our use of cash and adjusting [our] capital structure….This is all about maintaining the strong financial help that we have enjoyed for years.
So it is suspended temporarily and we will look for an opportunity to get back into a share repurchase mode.
Far from being “methodical and systematic,” Lubrizol’s share repurchase program appears to have been more on the “mercurial and arbitrary” side, given the fact that a share repurchase was decidedly more attractive with the stock at its “suspended temporarily” conference call valuation of less than 6-times trailing EBITDA than at its “methodical and systematic” share repurchase valuation of nearly 8-times trailing EBITDA.
Now, if Lubrizol management had decided to “get back into a share repurchase mode” during the early March 2009 market panic, with its stock trading briefly at $25 a share, just below 4.5-times trailing EBITDA, we’d be nominating Lubrizol’s Treasurer for a spot in the Warren Buffett pantheon of Rational Investing.
But they did not.
Thanks to a sharp-eyed reader with something of a rooting interest in the stock, we returned to Lubrizol’s most recent earnings call—specifically the part where Mr. Cooley discussed the sources and uses of Lubrizol’s ample cash flow—via the indispensible StreetEvents:
Based on these assumptions, we project our year-end cash balance will be in the range of $800 million to $900 million. While our strong operating cash flow and first-quarter financing activities have provided us with increased liquidity. We plan to remain cautious in our approach to the use of our available cash.
It is reasonable to assume that we will hold excess cash for the foreseeable future, especially in light of the current environment of volatile commodity prices and uncertain demand. We do have the ability to pre-pay as much as $150 million of debt without incurring a penalty.
In fact, the company actually increased its estimated shares outstanding, thanks no doubt to management option grants bloating the share count.
As for share repurchases, Mr. Cooley said:
At this time, we have no plans to reinstate our share repurchase program.
Hey, having missed the stock at $35, and $30, and $25—and the last trade occurring at $61.69 a share—who could blame them?
But we’ll make a bet here.
In the currency of one of our old hedge fund friends, we’ll bet dollars to donuts the next time Lubrizol buys stock, it’s not at $25, $30, or $35—rational as those prices proved to be. We’ll bet it’s at a multiple of one or all of those prices.
And Wall Street’s Finest will applaud them for “Returning Value to Shareholders.”
Ah, the opportunity cost of thinking like everyone else!
I Am Not Making This Up
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Posted by Jeff Matthews at 7:56 AM