Covid-19 illuminates corporate buyback issues

Author: John Crabb | Published: 3 Apr 2020
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The Covid-19 crisis has caused a major drop in the number of corporates taking part in share buyback programmes in the US, leading many to ask if the practice should be more heavily regulated.

As the crises leads to tens of millions of layoffs globally, dividends to be cancelled and trillions of stimulus dollars to be provided throughout the economy, the financial sector is once again under public scrutiny – with share buyback programmes at the centre.

S&P500 buybacks for 2019 totaled $728.7 billion – down 9.6% from the record $806.4 billion set in 2018. Apple led the way and spent $22.1 billion – up from last quarter’s $17.6 billion.

Chevron, the largest oil producer in the US, told IFLR that it is looking at and adjusting to an environment where supply and demand is changing dramatically. "We have announced changes to reduce our capital spending by about 20% or $4 billion," said Sean Comey, senior advisor of external affairs.

"Our financial priorities are unchanged. The dividend is our number one priority. We've actually increased our annual dividend payout for 33 consecutive years," he added. Chevron has not cut its dividend since 1934 – in the depths of the Great Depression – and has a long track record of a secure dividend.


"We are taking strong actions to preserve cash today, not just with the capital spending reductions, but with the termination of our share repurchase programme"


"We came into this environment with the strongest balance sheet and lowest breakeven in the industry, and we're taking strong actions to preserve cash today, not just with the capital spending reductions, but with the termination of our share repurchase programme and the continuation of efforts that we have already announced to further reduce costs, improve margins and improve efficiency in our underlying business," continued Comey.

"All these are measures align with our financial priorities to preserve long term growth but sacrifice in the short term in response to the market."

See also: Inside NYSE's response to the Covid-19 crisis

According to Standard & Poor’s the outlook for buybacks in 2020, is unsurprisingly grim: "Covid-19 has significantly changed the 2020 landscape, as dividends are under pressure and buybacks appear to be gasping for air," said Howard Silverblatt, senior index analyst for S&P Dow Jones Indices. Pre-Covid-19 estimates predicted 2020 buybacks would come close to or exceed the $806 billion record set in 2018.

Flows

The CARES Act, the US government's $2 trillion stimulus bill, will provide $425 billion in loans to corporations of all sizes across the country, including $58 billion alone for the airline industry. The airline industry, which has put billions of dollars of profit into share buyback programmes, has suddenly found itself almost helpless, and requesting bailouts from the US taxpayer.

American Airlines alone has spent about $12.4 billion on stock repurchases since 2014: a significant segment of its free cash flows.

One source, the director of equity derivatives at a major US bank, told IFLR that these major programmes are a product of low rates that eventually led to an abusive situation. "These companies thought that there has been no reason to invest in new projects because of uncertainty. When there is no clarity, most have simply continued to conduct stock buybacks," he said. "There is a certain degree of abuse going on. I think the question is how you go about regulating that. Capital structure is something that should be at the purview of management."

When companies conduct buybacks, the liquidity that could help them cope when sales and profits decline in an economic downturn is no longer available.

The director added that boards should be advising corporates to stop buying buybacks and start investing in companies, resources and people. "If you're in the business, you're in the business to provide a product or service. A stakeholder versus shareholder mentality is starting to change," he said. "This is one aspect of that change. Most companies will realise that only having a shareholder focus is not good policy."

See also: M&A market stalls amid Covid-19 uncertainty

Even President Donald Trump has warned US corporates against using this bailout money to conduct buybacks, and the legislation itself states that those utilising the loan programme are not allowed to conduct buybacks during the period of the loan, excepting pre-existing contractual obligations.

In 2003 the Securities and Exchange Commission amended the stock repurchase safe harbor rule under Rule 10b-18 of the Securities Exchange Act of 1934. The amendment allowed companies to buy stock in the market and not be accused of doing so for manipulative purposes.

A lot of stock repurchases are driven by activist investors insisting corporates do not squander generated cash, make bad investments or give cash back to the shareholders.

"The recent tax reform was sold to the public under the proviso that companies will use savings to reinvest in the business and spend cap, creating jobs and stimulating the economy," said Richard Truesdell, capital markets partner at Davis Polk & Wardwell. "In fact, many of them didn't, instead putting more into share buyback programmes."


"Recent tax reform was sold to the public under the proviso that companies will use savings to reinvest in the business"


Even before the coronavirus crisis a number of politicians, such as Bernie Sanders, promoted policy to block all stock buybacks. Maxine Waters introduced legislation to ban it altogether. "A lot of people believe it is an evil thing," added Truesdell. . 

If corporates never require bailouts, there would be no concern. Running a business so that shareholders get wiped out if there is a crisis is a concern, but a risk a company can choose to make of its own accord.

"Even a free market libertarian like me would agree that if a company is going to the government to get a bailout, for either being too big to fail, like the banks, or being an essential part of infrastructure like an airline, then it does make sense to have limitations," said Truesdell. "Because companies have siphoned off all their cash to the point that when the bad times come, they then turn to the government and the taxpayer to bail them out."

In terms of regulatory action, the director of equity derivatives envisages regulation to prevent corporates from altering the total share count using buybacks.

"Keeping the share count constant signifies that companies are not only concerned with stocks being over or under priced," said the equity director, but are simply looking to make sound investments. "There needs to be some degree of discipline enforced by the government on the lender." 

Back into the fold

Despite the negative press surrounding buybacks, and the restrictions on many of those undertaking programmes, S&P predicts the numbers will bounce back eventually.

This is a highly political issue with complex market dynamics. Under a Democratic administration, whether that be the president in the White House or both houses of Congress, there would likely be calls for change – the extent of which would also depends on which candidate is eventually put forward.

"Even if the government didn't do something, a lot of companies are more concerned with liquidity and cash at this point," said Silverblatt. "It will be interesting to see when Apple reports. Filings usually have a breakdown to see how many and what kind of comments a company receives. Coronavirus is going to be mentioned in every press release."

See also: Increased private equity interest in performance fees over return levels