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Let's say a company trades at $100 and that they can get a loan of $1m for 2% interest (total payment due: $1m in principal plus $20k in interest.) They use th

by v64 7y ago

Let's say a company trades at $100 and that they can get a loan of $1m for 2% interest (total payment due: $1m in principal plus $20k in interest.) They use the loan to buy 10,000 shares at $100. The company does so anticipating the price of the shares will go up. Let's say the price is now $150. They sell the shares and get back $1.5m. They return the $1.02m owed for the loan and pocket the rest as profit. If you believe the growth of your company's stock price will exceed the interest rate, you can make a profit using debt to finance a buy back.

supercanuck 7y ago
>They return the $1.02m owed for the loan and pocket the rest as profit. This makes sense. Reduction in debt with the proceeds. Just like the other poster, you are concocting a strategy that is not happening. You hypothetical does not apply. Instead, the companies are simply taking on debt and keeping it on their balance sheet.Now that there is a downturn, they cannot service the debt and need funding to operate (e.g. bailout) They are betting that the government will keep rates low or fund them in a time of crisis because they are too big, too important to fail. They've also bought up competition so they cannot just " go away" and let new entrants enter the market.
- v64 7y ago
  > Instead, the companies are simply taking on debt and keeping it on their balance sheet. Yes, my example is an admitted oversimplification. I was directly answering the question "why would a company use debt to finance a buy back?", not "why would a company use debt to finance a buy back and then leave that debt on their balance sheet for an extended period of time?" Although I suspect the answer to that question is that they didn't want to leave profit on the table and wanted to continue riding out the bull run, then got caught by the fastest bear market in history and weren't able to get out at a profit. Or that they believed they could eventually service the debt without having to reissue shares at all and ran out of time because of the crash.
nkurz 7y ago
While there might be situations where the math works out as you suggest, it seems awkward to assume both that the volume purchased by the company significantly increases the price of the stock, while at the same time assuming that the company can purchase and sell all the shares at a set price. If we assume a ramp up in price as the company purchases shares, and an equal ramp down as they sell, they end up even, rather than with a giant profit. At the least, we should probably assume that the sale at the end results in the same drop as the purchase at the beginning.
- v64 7y ago
  > while at the same time assuming that the company can purchase and sell all the shares at a set price For large cap companies that trade tens of millions of shares a day, you can figure out how much you can buy without moving the market. For less liquid stocks, you can also spread the buys out over a period of time to aim toward an average buy-in price. The phenomenon you describe is called slippage [1], and those entering and exiting large positions are aware of it. > it seems awkward to assume both that the volume purchased by the company significantly increases the price of the stock I'm not implying that the reason why the stock price goes up is because the company is buying shares. The purchase may be done based on quarterly/yearly projections showing X% growth can be expected in the stock price in the future. [1] https://en.wikipedia.org/wiki/Slippage_(finance) https://en.wikipedia.org/wiki/Slippage_(finance)

by v64 7y ago

supercanuck 7y ago

>They return the $1.02m owed for the loan and pocket the rest as profit. This makes sense. Reduction in debt with the proceeds. Just like the other poster, you are concocting a strategy that is not happening. You hypothetical does not apply. Instead, the companies are simply taking on debt and keeping it on their balance sheet.Now that there is a downturn, they cannot service the debt and need funding to operate (e.g. bailout) They are betting that the government will keep rates low or fund them in a time of crisis because they are too big, too important to fail. They've also bought up competition so they cannot just " go away" and let new entrants enter the market.

v64 7y ago
> Instead, the companies are simply taking on debt and keeping it on their balance sheet. Yes, my example is an admitted oversimplification. I was directly answering the question "why would a company use debt to finance a buy back?", not "why would a company use debt to finance a buy back and then leave that debt on their balance sheet for an extended period of time?" Although I suspect the answer to that question is that they didn't want to leave profit on the table and wanted to continue riding out the bull run, then got caught by the fastest bear market in history and weren't able to get out at a profit. Or that they believed they could eventually service the debt without having to reissue shares at all and ran out of time because of the crash.

nkurz 7y ago

While there might be situations where the math works out as you suggest, it seems awkward to assume both that the volume purchased by the company significantly increases the price of the stock, while at the same time assuming that the company can purchase and sell all the shares at a set price. If we assume a ramp up in price as the company purchases shares, and an equal ramp down as they sell, they end up even, rather than with a giant profit. At the least, we should probably assume that the sale at the end results in the same drop as the purchase at the beginning.

v64 7y ago
> while at the same time assuming that the company can purchase and sell all the shares at a set price For large cap companies that trade tens of millions of shares a day, you can figure out how much you can buy without moving the market. For less liquid stocks, you can also spread the buys out over a period of time to aim toward an average buy-in price. The phenomenon you describe is called slippage [1], and those entering and exiting large positions are aware of it. > it seems awkward to assume both that the volume purchased by the company significantly increases the price of the stock I'm not implying that the reason why the stock price goes up is because the company is buying shares. The purchase may be done based on quarterly/yearly projections showing X% growth can be expected in the stock price in the future. [1] https://en.wikipedia.org/wiki/Slippage_(finance) https://en.wikipedia.org/wiki/Slippage_(finance)