Stock Buybacks May Be a Placebo, Not a Real Cure
You’re the chief executive of a mid-size company. Your stock has plunged to $2 from $12 this year, even though you believe that your business is going well. What do you do?
In recent weeks, many small and medium-size Southland firms have decided that if no one else wants their stock, they’ll buy it themselves. Such buybacks have multiplied as more area stocks have fallen to embarrassing “penny” levels of $5 or less.
Corporate stock buybacks aren’t new, of course. But the practice is more controversial now, because some executives question the wisdom of draining company cash to retire stock on the eve of what could be a deep recession. Also, experts caution that if management’s goal is to stop its stock from sliding, a buyback program may prove futile in a severe bear market.
In any case, many of the recent buyback announcements are aggressive. Beverly Hills-based Salick Health Care, which runs cancer treatment centers, said on Oct. 15 that it would spend as much as $5 million to buy back stock or its 7.25% convertible bonds or some combination of the two. If the money were spent solely on the stock, Salick would retire 19% of its shares.
The key phrase in most buyback announcements is “up to”--as in, up to 500,000 shares. That doesn’t mean that the firm will buy the entire sum. In fact, some companies that announce plans to buy never do. That was frequently the case after the October, 1987, market crash: Many buybacks planned then never happened, because stocks stabilized.
Today, however, as smaller stocks in particular are deserted by investors, more of those companies say simple financial analysis suggests a buyback. “For us, the best use of cash is to put it back into the company,” argues Michael Fiore, senior vice president at Salick.
Companies reason this way:
* If a firm expects to grow at an annual rate of 15% or better, management can argue that buying its own equity is a smarter use for cash than leaving it to earn 7.5% in a money-market fund.
* Likewise, when a stock’s price is below the company’s book value per share--the net value of its assets--a buyback allows the company to reinvest in itself at an extraordinarily cheap price.
Those examples simplify the thought process, but the bottom line is that retiring stock can easily be justified mathematically by many firms.
From the shareholders’ point of view, the benefits are easy to see as well. As stock is retired by the company, the remaining shareholders own more of the business, and future earnings are spread over fewer shares. Your slice of the pie grows. Also, there is at least the expectation that the company’s purchases in the open market will help support the stock price.
But experts warn shareholders against counting on company buybacks to put a floor under stock prices, beyond some temporary psychological support immediately after a buyback announcement. Lloyd Greif, corporate finance chief at brokerage Sutro & Co. in Los Angeles, notes that federal rules allow companies to buy their shares only after “upticks”--a rise in the price from the previous trade. So, in a free fall, a buyback plan can’t even be implemented.
Thomas Whitten, chief financial officer at El Monte-based electronics distributor Marshall Industries, says his firm isn’t considering a 500,000-share buyback to keep the stock price up but rather because “it’s a question of what we feel would be a good use of the company’s resources.” As for the stock, he says, “I think the market is going to do what it’s going to do.”
What about concerns that management ought to be conserving cash for the recession ahead? The companies that are most aggressive with their buybacks contend that they will leave plenty of funds for operations. “We’ll have enough cash to continue to grow the business,” Salick’s Fiore says. “We feel we can do both.”
The companies in the best shape to buy back stock are those with no debt and no pressing need for their cash. Canoga Park-based New Image Industries, for example, is debt-free, and its cash hoard alone is worth almost $3 a share. The stock trades for $2.875 a share. So the market is barely valuing the computer-imaging systems company for its underlying cash, let alone for the value of its property and its franchise.
Still, the new wave of buybacks may actually be detrimental to smaller companies’ stocks over the long term: As shares are retired, already-volatile small stocks may become more volatile in their price swings because there will be fewer shares to trade. “Our stock is thinly traded now, and we’re trying to (fix) that. Our buyback is contrary to that goal,” one Southland executive admits.
What’s more, it’s a sad commentary on the stock market and the economy that many young companies will end up spending their dollars on their own paper rather than on new research or expansion. Buybacks may make corporate officers and shareholders feel better, but they won’t do much for the nation’s long-term economic picture.
STOCK BUYBACK MANIA Here are some of the Southland companies that have recently announced plans to buy back some of their shares, as the stocks’ prices have plunged: Potential Stock price buyback Percent of and change Company (shares 000s) shares year-to-date Salick Health 1,052* 19.0 4 3/4 -56% Digital Sound 2,850 16.0 1 3/4 -79% New Image Indus. 500 12.0 2 7/8 -77% Vidmark 500 10.0 4 -68% Marshall Indus. 500 5.9 18 -5% Diagnostic Prods. 500 4.2 25 1/2 -24%
* Company would spend up to $5 million, equal to this share total at current price. Source: Companies listed
