The big buyback is back. Last week, two of the world's biggest oil companies, ExxonMobil of the US, and the Anglo-Dutch group Royal Dutch/Shell, announced large share repurchase plans.
ExxonMobil is planning to resume the share buyback programme, which returned a whacking $26 billion to shareholders between 1983 and 1999. Shell plans to take advantage of new Dutch legislation that will allow a multi-year repurchase of shares worth between $1.5 billion and $4.8 billion annually. Another big oil company, BP Amoco, has just completed the first phase of its repurchase programme, worth $974 million.
Why do it? A new study, sponsored by the Financial Executives Research Foundation (Ferf), a New York-based financial research organisation, looks at 200 companies that announced and completed share repurchase programmes between 1991 and 1996. It concludes that there are five main reasons for buybacks:
To increase the share price.
To rationalise the capital structure - the company believes it can sustain a higher debt-equity ratio.
To substitute dividend payouts with share repurchases (because capital gains may be taxed at rates lower than dividend income).
To prevent dilution of earnings - caused, for example, by the issue of new shares to meet the exercise of stock option grants.
To deploy excess cashflow.
ExxonMobil's reasoning, according to chairman Lee Raymond, seems to be a combination of ingredients four and five, with a pinch of number two. The company's financial position is strong - net debt to capital of 10 per cent - and strong first-half earnings generated a cash surplus of more than $8 billion in the first half of 2000. The theory is that cash is better in shareholders' hands than sloshing around the balance sheet serving no useful purpose. The share purchases would "offset dilution and . . . reduce shares outstanding," the company said.
The buyback tendency became strong at the height of the recent bull market last year and early this year, drawing fire from many analysts. But Rick Escherich, managing director in the mergers and acquisitions group of J.P. Morgan in New York, says activity has now slowed.
As for reviving the company's share price, J.P. Morgan's research indicates that "open market" repurchases, like those announced this week by ExxonMobil and Shell, are less effective than tender offers or Dutch auctions, where the commitment to buy is clearer. Escherich says that most companies do follow through on announcements of open-market repurchases, but the share price reacts with only a small uptick.
The Ferf study of 200 companies takes a closer look at whether open-market buybacks achieved the companies' longer-term objectives. In general, the sample companies seem to have benefited from the schemes.
The study paints a picture of misunderstood companies with above-average sales growth and returns on equity, but below-average share-price growth. Distraught, they opt for a share repurchase and in the three years after completing the programme, share price growth improves until it almost falls in line with industry averages.
Evidence gathered by S.G. Badrinath of Rutgers University and Nikhil Varaiya of San Diego State University, did not, however, support the theory that buybacks replace dividend payments.
J.P. Morgan's Escherich points out that many companies now consider share buybacks to be "a regular part of distributing cash to shareholders: it increases earnings per share, and it's tax-efficient".
