Buybacks, Takeovers Slump Amid ‘Enronitis’
Among the many casualties of the Enron debacle and its fallout, count corporate America’s appetite for its own paper.
In January, a mere 18 companies announced plans to repurchase stock, and the total buyback commitment was $1.8 billion, according to Thomson Financial Securities Data.
Those figures compare with an average of 64 buyback announcements each month over the last two years and an average total dollar value of $13.6 billion a month.
So far in February, 11 companies have committed a total of $7.1 billion to repurchase shares. But $5 billion of that was from one company--Johnson & Johnson.
Likewise collapsed is many U.S. companies’ urge to merge. Deals worth $21.1 billion were announced in January, the weakest activity for any January since 1994, and a third of the December dollar volume, according to Thomson Financial.
With February more than half over, the value of deals announced so far stands at just $10.4 billion.
The relative dearth of buybacks and takeovers significantly dents two key sources of demand for stock. Little wonder the market is struggling this year, after the heady rally of the fourth quarter. With Friday’s sell-off, the blue-chip Standard & Poor’s 500 index is down 3.8% year to date. The Nasdaq composite is off 7.4%.
Amid the spreading firestorm over the trustworthiness of corporate accounting and increasing doubts about the credibility of management in general, it isn’t a coincidence that stock buybacks and takeovers have taken a back seat to other concerns since Jan. 1, some Wall Street pros say.
Company managers typically don’t put out news releases to admit it, but they now may be preoccupied with making sure their balance sheets and income statements are honest. Others may be trying to figure out how to explain numbers that no longer pass the smell test, if they ever did.
After all, this fourth-quarter-earnings reporting season, now winding down, really is like no other: The Securities and Exchange Commission is committed to closely reading the 2001 annual reports of every one of the Fortune 500 companies, the agency announced in late December.
The SEC said its examiners will focus on “disclosure that appears to be critical to an understanding of each company’s financial position and results, but which, at least on its face, seems to conflict significantly with generally accepted accounting principles or Commission rules, or to be materially deficient in explanation or clarity.”
Companies that aren’t worried about their accounting may face more fundamental obstacles to merger deals or buybacks.
One critical issue is financing: In the energy, utility and telecom sectors, in particular, lenders have become much more skittish about extending credit, given the mounting concerns about the legitimacy of companies’ financial data.
Last week, telecom giant Qwest Communications International, which owns the former Baby Bell firm U.S. West, found itself frozen out of the market for commercial paper, a principal means of short-term financing. The company was forced to draw down bank lines of credit worth $4 billion, and said it would look to sell some assets and cut back capital spending to allay investors’ fears about its viability.
Most analysts say there still is no sign of a broad-based credit crunch in the economy. Even so, “We could be seeing more companies recognizing that they don’t have as much cash as they need to fund operations” in the near term, said Tom McManus, investment strategist at Banc of America Securities in New York. That conclusion may be leading more firms to scale back their ambitions, he said.
Many companies, of course, would prefer to pay for takeover deals using stock rather than cash or loans. But with share prices sliding again this year, using stock as merger currency becomes less feasible. Potential acquirers have to give away more equity when share prices are lower, something they’re reluctant to do. And potential targets become less interested in receiving stock that’s in danger of further devaluation.
The same may be said of corporate executives with regard to their own shares: One reason companies are buying back fewer shares is that many of their insiders have stopped exercising stock options, some analysts say.
Companies often buy back shares so they can hold them in reserve and re-release them when employee options are exercised.
When “nobody is exercising options, there’s no need to do buybacks,” said Patrick McGurn, corporate programs director for investor advisory service Institutional Shareholders Service in Rockville, Md.
One logical reason for corporate insiders to stop exercising options would be because those options are underwater--meaning the market price is below the exercise price.
It’s also conceivable that insiders whose exercise price is below their stock’s market price are confident their shares will rise in value this year, meaning they don’t feel pressure to exercise the options and immediately sell the shares.
Apart from supplying options programs, a major motivation behind stock buybacks in recent years was that companies viewed their shares as being undervalued in the market.
Using capital to repurchase shares was seen as the best way to reward shareholders: The buyback programs helped boost stock prices, while at the same time shrinking the total number of shares outstanding and thus raising earnings per share calculations.
The SEC even helped abet buybacks after Sept. 11 by relaxing rules that had restricted some companies’ stock-purchase activities. That fueled a surge in buyback announcements in September.
What has troubled some analysts is that many companies were eager to go deep into debt to finance their buyback programs in the late 1990s. Worse, in many cases companies were buying shares at levels far above today’s prices. “Replacing equity with debt was considered a brilliant move,” noted Robert Willens, a tax expert at Lehman Bros. in New York.
Now, that debt is coming back to haunt companies. And some recent buyback announcements have been poorly received in the market because of fears that companies risk more harm than good by using cash to repurchase shares.
Neither McDonald’s Corp. nor Johnson & Johnson saw an immediate lift in their stock prices last week after announcing large buyback programs.
Garbage hauler Waste Management Inc.’s stock has fallen since Feb. 1, when the company said it may buy back as much as $1 billion of stock annually. Credit-rating firm Moody’s Investors Service reacted to the company’s plans by changing its credit outlook for the firm to negative from positive--a harsh reminder that financial alchemy that is glorified in a bull market can be viewed as poisonous when the wind changes.
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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to: www.latimes.com/petruno.
