6 ms·

Over the past decade, companies have taken advantage of low rates both to grow their businesses and reward shareholders. Total corporate debt has swelled from

by apo 8y ago

Over the past decade, companies have taken advantage of low rates both to grow their businesses and reward shareholders. Total corporate debt has swelled from nearly $4.9 trillion in 2007 as the Great Recession was just starting to break out to nearly $9.1 trillion halfway through 2018, quietly surging 86 percent, according to Securities Industry and Financial Markets Association data. Other than a few hiccups and some fairly substantial turbulence in the energy sector in late-2015 and 2016, the market has performed well. "Reward shareholders" is code for stock buybacks - the practice of a company using ultra-low interest financing to buy its own stock on margin. It's an unsustainable way to manipulate the price/earnings ratio, and thereby make a company look like a better buy than it is. Buybacks in turn have been a major source of funding for the stock market's unprecedented run: https://seekingalpha.com/article/4156578-buyback-bubble-will-end-badly https://seekingalpha.com/article/4156578-buyback-bubble-will... I suspect those looking for a soft landing here haven't considered the reversible nature of this debt-fueled stock market rally. Nor have they considered the amplifying effect of debt on the upside and downside.

eej71 8y ago
I do not believe share repurchase programs are done "on margin".
- tcoppi 8y ago
  If they borrow money to purchase the stock that's effectively what it is, a margin loan.
  - eej71 8y ago
    Would be interesting to see some examples of this - and if so - what collateral if anything sits behind the loan?
    - matwood 8y ago
      Apple has done this multiple times because loan rates were/are cheaper than paying taxes to repatriate cash.
      - eej71 8y ago
        Ideally you have a reference to an EDGAR filing for this?
        matwood 8y ago
        Google is your friend. There are many cases, but this is one of the more recent. https://www.bloomberg.com/news/articles/2017-09-05/apple-returns-to-debt-market-to-fund-share-buybacks-dividends https://www.bloomberg.com/news/articles/2017-09-05/apple-ret...
    - PopeDotNinja 8y ago
      I know less about shareholder buybacks than I do about divideds, but they are pretty similar to dividends. A buyback is returning $X in bigger chunks to a few shareholders, and a dividend it returning a $X to all shareholders. A dividend usually drops stock value in line with amount of dividend paid out, so in a sense you could think if it as the company saying "I'm buy 1% of your $100 share, so you get $1 and the share is now worth $99". Anytime a company pays a dividend AND increases their outstanding debt in the same time period, you could draw ths conclusion that they financed the dividend using debt. Check out the financials for Vector group... https://finance.yahoo.com/quote/VGR/financials?p=VGR https://finance.yahoo.com/quote/VGR/financials?p=VGR On the summary page you can see they pay about a 15% dividend. On their income statement you can see their net income is less than $100 million USD. On the balance sheet, you can see the long term debt has increased by a serveral hundred million over the last few years. That dividend sure sounds like it is financed by debt, although you'd have to dig into what is really going on to know for sure.
- gomox 8y ago
  If the buyback is funded with credit, it's done on margin. I'm not sure how prevalent that has been during the last bull run.
- TheSoftwareGuy 8y ago
  Nor does "reward shareholders" necessarily mean stick buybacks. It could just as easily refer to paying out dividends.
  - stevehawk 8y ago
    ^-- This right here. This article is from 2012 but illustrates the point (it's also why I left the company, they restructured debt, issued a dividend which, even though they're publicly traded they were(are?) 75% held by Carlysle Group so it was basically a self bonus, then cut employee benefits) https://www.forbes.com/sites/abrambrown/2012/07/11/booz-allen-mulling-1-billion-special-dividend/#573f37f427af https://www.forbes.com/sites/abrambrown/2012/07/11/booz-alle...
- gruez 8y ago
  considering money is fungible, you could make the case that any buyback done close to a loan could be construed as being "on margin"
shaki-dora 8y ago
I don’t believe it’s fair to call the practice “unsustainable” without qualifications. It’s just the opposite of issuing stock. Even when done with borrowed money, it is simply replacing one source of funding (investment) with another (debt). When interest rates are low, the latter becomes attractive. If/when they rise, trouble may ensue. But for a profitable company, the normal, entirely adequate, reaction would just be the reverse transaction, retiring the remaining debt with newly issued stock.
- freehunter 8y ago
  It's an unsustainable way to prop up a share price in a declining market. The market could stay in decline longer than you can stay fiscally solvent.
  - shaki-dora 8y ago
    Those are some phrases I have heard before. And I agree that those posting them did come off somewhat intelligent, usually. Unfortunately, I don't quite get the intended meaning here. How is a declining market threatening a profitable company that, at some point in its past, bought back shares? There are no on-going financial commitments a company has that are tied to the daily fluctuations of the stock market. Even if they have taken on debt to finance a buyback, a future decline of the stock market has no bearing on them, except to possibly make it less lucrative to issue new stock. As long as they make a profit in their core business, and those profits allow them to pay the 3% or 4% interest on any debt, they are completely save. A rise in interest rates does have a meaningful impact here, yes. But (a) interest rates have been rather stable for going on 40 years now, and this is a well-known risk that is an obvious part of any decision to take on debt. It can, and often is, also be hedged by agreeing to fixed interest rates, or hedging.
    - freehunter 8y ago
      Buying back shares is not unsustainable in and of itself. Buying back shares to artificially inflate your stock price is. The unsustainable part is giving investors the impression that, while the Dow plunges 500 points, your stock remains stable. Then when your buybacks stop and your shares plummet with the rest of the market, it gives the impression that something suddenly happened and your company is in a dire situation. Either you keep buying shares to inflate the value (which gets expensive) or you stop and accept that your shares will go down (which looks worse now that your stock price has not declined with the rest of the market). Either way, if you're using buybacks to keep your stock price up in a market that's down, you're going to get burned eventually.
freehunter 8y ago
I keep an eye on a lot of tech stocks, and I think it's crazy how much crap companies like IBM and Oracle got 3-5 years ago for their stock buybacks [1] contrasted to how praised stock buybacks are now [2]. The impact back then was the market was great but IBM/Oracle/etc's share prices weren't doing great. The impact now is the market is not doing great, and stock buybacks are a band-aid over the inevitable decline. Anyone who doesn't see that is going to be caught off guard when the money runs out, the buybacks stop, and the market crashes "overnight". In reality, the market is crashing right now, it's just hidden behind trickery designed to artificially inflate the value of the market. It's like if I lost my job but kept financing my same lifestyle out of my savings account. Eventually that savings will run out and reality will hit like a ton of bricks, and no one will have seen it coming. [1] https://www.fool.com/investing/general/2014/12/05/share-buybacks-are-killing-ibm.aspx https://www.fool.com/investing/general/2014/12/05/share-buyb... [2] https://www.fool.com/investing/2018/12/09/why-investors-should-cheer-facebooks-stock-buyback.aspx https://www.fool.com/investing/2018/12/09/why-investors-shou...
- shaki-dora 8y ago
  I think you are operating from a seriously mistaken assumption of how stock buybacks work. When a company buys their own stock, there are simply fewer shares free-floating, in the hands of owners. The company's profits therefore are divided among a smaller group, and each share receives a larger percentage of those profits. Imagine an extreme case where McDonald's buys every single share but one. That remaining stock-owner will therefore own 100% of McDonald's, and get every last profit made from the world's obese. All this requires no ongoing buybacks from the company. You do it once, and because the denominator shrinks, each stock appraises. After that, as long as profits remain stable, earnings per share will, and so should, absent external factors, the stock price.
  - Jimpulse 8y ago
    The kicker is that these buybacks were financed with debt,
  - freehunter 8y ago
ptero 8y ago
I personally think there are many reasons to be super careful and expect significant glitches in the economy, stock and especially bond markets, etc. in the next few years. We (US) have been on the up leg of the cycle for very long and a lot of people are used to great paper returns and a feeling of wealth that comes with it. They are also not ready for a change and few entertain "what if" scenarios -- kind of like 2006 when professionals were stretching to buy expensive houses on 2 salaries and would argue "no problem -- if one of us loses a job we will sell the house. price dropping 20%? never going to happen". That said, I also do not see "reward shareholders" as necessarily sinister. Many companies this late in the cycle are sitting on a LOT of cash (income from operations) and do not see enough opportunities to invest in long term growth. Thus they are using it to pay dividends or buy their own stock. In fact, "reward shareholders" is exactly what the company should be doing in such case and neither of this is a sign of the problem. Problems may still happen, but I doubt about buybacks being the primary cause. My 2c.
sonnyblarney 8y ago
It's fair to separate the issues of borrowing and stock-buybacks ... specifically because the borrowing has to be based on the credit worthiness of the company, and the stock-buybacks are a separate thing entirely. Using debt instead of equity is a rational thing for companies to do if debt is really cheap. The 'higher stock price' as a result of the buybacks is effectively an adjustment of the equilibrium to that fact: the company is taking advantage of cheap sources of financing. If the company is doing sneaky things like hiding problems, or if the lenders are failing to do due diligence .... then yes, this can be a problem. Or of companies are over-leveraging - again a potential problem. But tapping into cheap debt, even combined with stock-buybacks - this could definitely be characterized as an intelligent kind of financial engineering, I don't think that it should be in and of itself viewed as suspicious or negative. It's just the CFO doing their job, mostly. Also ... stocks are quite expensive right now by most measures, so I'm not sure how much buybacks make sense in that context at this moment.
bogomipz 8y ago
>""Reward shareholders" is code for stock buybacks - the practice of a company using ultra-low interest financing to buy its own stock on margin." I'm curious why this would be done on margin. Are they using call options then for their own stock?

by apo 8y ago

eej71 8y ago

I do not believe share repurchase programs are done "on margin".

tcoppi 8y ago
If they borrow money to purchase the stock that's effectively what it is, a margin loan.
- eej71 8y ago
  Would be interesting to see some examples of this - and if so - what collateral if anything sits behind the loan?
  - matwood 8y ago
    Apple has done this multiple times because loan rates were/are cheaper than paying taxes to repatriate cash.
    - eej71 8y ago
      Ideally you have a reference to an EDGAR filing for this?
      - matwood 8y ago
        Google is your friend. There are many cases, but this is one of the more recent. https://www.bloomberg.com/news/articles/2017-09-05/apple-returns-to-debt-market-to-fund-share-buybacks-dividends https://www.bloomberg.com/news/articles/2017-09-05/apple-ret...
  - PopeDotNinja 8y ago
    I know less about shareholder buybacks than I do about divideds, but they are pretty similar to dividends. A buyback is returning $X in bigger chunks to a few shareholders, and a dividend it returning a $X to all shareholders. A dividend usually drops stock value in line with amount of dividend paid out, so in a sense you could think if it as the company saying "I'm buy 1% of your $100 share, so you get $1 and the share is now worth $99". Anytime a company pays a dividend AND increases their outstanding debt in the same time period, you could draw ths conclusion that they financed the dividend using debt. Check out the financials for Vector group... https://finance.yahoo.com/quote/VGR/financials?p=VGR https://finance.yahoo.com/quote/VGR/financials?p=VGR On the summary page you can see they pay about a 15% dividend. On their income statement you can see their net income is less than $100 million USD. On the balance sheet, you can see the long term debt has increased by a serveral hundred million over the last few years. That dividend sure sounds like it is financed by debt, although you'd have to dig into what is really going on to know for sure.
gomox 8y ago
If the buyback is funded with credit, it's done on margin. I'm not sure how prevalent that has been during the last bull run.
TheSoftwareGuy 8y ago
Nor does "reward shareholders" necessarily mean stick buybacks. It could just as easily refer to paying out dividends.
- stevehawk 8y ago
  ^-- This right here. This article is from 2012 but illustrates the point (it's also why I left the company, they restructured debt, issued a dividend which, even though they're publicly traded they were(are?) 75% held by Carlysle Group so it was basically a self bonus, then cut employee benefits) https://www.forbes.com/sites/abrambrown/2012/07/11/booz-allen-mulling-1-billion-special-dividend/#573f37f427af https://www.forbes.com/sites/abrambrown/2012/07/11/booz-alle...
gruez 8y ago
considering money is fungible, you could make the case that any buyback done close to a loan could be construed as being "on margin"

shaki-dora 8y ago

I don’t believe it’s fair to call the practice “unsustainable” without qualifications. It’s just the opposite of issuing stock. Even when done with borrowed money, it is simply replacing one source of funding (investment) with another (debt). When interest rates are low, the latter becomes attractive. If/when they rise, trouble may ensue. But for a profitable company, the normal, entirely adequate, reaction would just be the reverse transaction, retiring the remaining debt with newly issued stock.

freehunter 8y ago
It's an unsustainable way to prop up a share price in a declining market. The market could stay in decline longer than you can stay fiscally solvent.
- shaki-dora 8y ago
  Those are some phrases I have heard before. And I agree that those posting them did come off somewhat intelligent, usually. Unfortunately, I don't quite get the intended meaning here. How is a declining market threatening a profitable company that, at some point in its past, bought back shares? There are no on-going financial commitments a company has that are tied to the daily fluctuations of the stock market. Even if they have taken on debt to finance a buyback, a future decline of the stock market has no bearing on them, except to possibly make it less lucrative to issue new stock. As long as they make a profit in their core business, and those profits allow them to pay the 3% or 4% interest on any debt, they are completely save. A rise in interest rates does have a meaningful impact here, yes. But (a) interest rates have been rather stable for going on 40 years now, and this is a well-known risk that is an obvious part of any decision to take on debt. It can, and often is, also be hedged by agreeing to fixed interest rates, or hedging.
  - freehunter 8y ago
    Buying back shares is not unsustainable in and of itself. Buying back shares to artificially inflate your stock price is. The unsustainable part is giving investors the impression that, while the Dow plunges 500 points, your stock remains stable. Then when your buybacks stop and your shares plummet with the rest of the market, it gives the impression that something suddenly happened and your company is in a dire situation. Either you keep buying shares to inflate the value (which gets expensive) or you stop and accept that your shares will go down (which looks worse now that your stock price has not declined with the rest of the market). Either way, if you're using buybacks to keep your stock price up in a market that's down, you're going to get burned eventually.

freehunter 8y ago

I keep an eye on a lot of tech stocks, and I think it's crazy how much crap companies like IBM and Oracle got 3-5 years ago for their stock buybacks [1] contrasted to how praised stock buybacks are now [2]. The impact back then was the market was great but IBM/Oracle/etc's share prices weren't doing great. The impact now is the market is not doing great, and stock buybacks are a band-aid over the inevitable decline. Anyone who doesn't see that is going to be caught off guard when the money runs out, the buybacks stop, and the market crashes "overnight". In reality, the market is crashing right now, it's just hidden behind trickery designed to artificially inflate the value of the market. It's like if I lost my job but kept financing my same lifestyle out of my savings account. Eventually that savings will run out and reality will hit like a ton of bricks, and no one will have seen it coming. [1] https://www.fool.com/investing/general/2014/12/05/share-buybacks-are-killing-ibm.aspx https://www.fool.com/investing/general/2014/12/05/share-buyb... [2] https://www.fool.com/investing/2018/12/09/why-investors-should-cheer-facebooks-stock-buyback.aspx https://www.fool.com/investing/2018/12/09/why-investors-shou...

shaki-dora 8y ago
I think you are operating from a seriously mistaken assumption of how stock buybacks work. When a company buys their own stock, there are simply fewer shares free-floating, in the hands of owners. The company's profits therefore are divided among a smaller group, and each share receives a larger percentage of those profits. Imagine an extreme case where McDonald's buys every single share but one. That remaining stock-owner will therefore own 100% of McDonald's, and get every last profit made from the world's obese. All this requires no ongoing buybacks from the company. You do it once, and because the denominator shrinks, each stock appraises. After that, as long as profits remain stable, earnings per share will, and so should, absent external factors, the stock price.
- Jimpulse 8y ago
  The kicker is that these buybacks were financed with debt,
- freehunter 8y ago

ptero 8y ago

I personally think there are many reasons to be super careful and expect significant glitches in the economy, stock and especially bond markets, etc. in the next few years. We (US) have been on the up leg of the cycle for very long and a lot of people are used to great paper returns and a feeling of wealth that comes with it. They are also not ready for a change and few entertain "what if" scenarios -- kind of like 2006 when professionals were stretching to buy expensive houses on 2 salaries and would argue "no problem -- if one of us loses a job we will sell the house. price dropping 20%? never going to happen". That said, I also do not see "reward shareholders" as necessarily sinister. Many companies this late in the cycle are sitting on a LOT of cash (income from operations) and do not see enough opportunities to invest in long term growth. Thus they are using it to pay dividends or buy their own stock. In fact, "reward shareholders" is exactly what the company should be doing in such case and neither of this is a sign of the problem. Problems may still happen, but I doubt about buybacks being the primary cause. My 2c.

sonnyblarney 8y ago

It's fair to separate the issues of borrowing and stock-buybacks ... specifically because the borrowing has to be based on the credit worthiness of the company, and the stock-buybacks are a separate thing entirely. Using debt instead of equity is a rational thing for companies to do if debt is really cheap. The 'higher stock price' as a result of the buybacks is effectively an adjustment of the equilibrium to that fact: the company is taking advantage of cheap sources of financing. If the company is doing sneaky things like hiding problems, or if the lenders are failing to do due diligence .... then yes, this can be a problem. Or of companies are over-leveraging - again a potential problem. But tapping into cheap debt, even combined with stock-buybacks - this could definitely be characterized as an intelligent kind of financial engineering, I don't think that it should be in and of itself viewed as suspicious or negative. It's just the CFO doing their job, mostly. Also ... stocks are quite expensive right now by most measures, so I'm not sure how much buybacks make sense in that context at this moment.

bogomipz 8y ago

>""Reward shareholders" is code for stock buybacks - the practice of a company using ultra-low interest financing to buy its own stock on margin." I'm curious why this would be done on margin. Are they using call options then for their own stock?