UK: UK companies jump on the buy-back bandwagon.

UK: UK companies jump on the buy-back bandwagon. - Last year, companies across Europe were handing back cash to shareholders hand over fist. A report by bankers JP Morgan reveals that share re-purchases tripled in value to $47.2 billion (£29 billion). Le

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Last Updated: 31 Aug 2010

Last year, companies across Europe were handing back cash to shareholders hand over fist. A report by bankers JP Morgan reveals that share re-purchases tripled in value to $47.2 billion (£29 billion). Leading the pack were UK companies such as Diageo (the merged Guinness and Grand Metropolitan), British Telecom and Reuters. But is there any logic in this or are companies just trying to keep in step with today's ideas of shareholder value and cost of capital?

The most likely company to launch a share buy-back is one that generates lots of cash but feels that it has run out of investment opportunities.

Shareholders may be pressing for a return of cash to reinvest elsewhere.

Another candidate is a poorly performing company that has disposed of a major subsidiary. Debt is generally cheaper than equity because shareholders expect higher returns for taking on the risk of dividend cuts or, at worst, liquidation. A buy-back will lower a company's cost of funds and improve its overall value. Less shares mean higher earnings per share and, in theory, a higher share price.

The trend is here to stay, claims Peter Warburton, equity market strategist at investment bankers Robert Fleming. 'In the UK, we shall be moving more towards the US model with more debt on company balance sheets and less equity,' he says. Buy-backs have been given an extra boost by the planned abolition of Advance Corporation Tax credits to non-paying investors - mainly the big pension and insurance funds.

But if it all sounds a bit too easy, Brian Walsh, former finance director of TI Group, sounds a note of caution. 'To say that shareholders are better off if you increase earnings per share by buying back shares is a fallacy.

It all depends on what price you pay for the shares. If you pay more than the shares are really worth, then you are destroying value for the remaining shareholders no matter what happens to earnings per share,' he states.

'If you pay less, and there is an obvious ethical problem here, then there is certainly a windfall. But if you pay the true value of the shares, in other words where the shares are correctly valued by the stock market, then you haven't achieved anything.'

As Jonathon Hinton of Arthur Andersen says: 'A share buy-back should only be done if there is no possible other use for the money. If the finance director turns up in two years' time to raise funds with a rights issue of shares, I don't think shareholders would be impressed.' Yet, perhaps it is irrelevant to discuss the merits of a share buy-back.

Cynics might say the main point is that by doing a buy-back, a company is showing that it understands the game and is sensitive to the whims of the market. That, in itself, should gain it a higher rating.

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