Share Buybacks - giving with one hand while taking with the other?

Flobberchops

Used the forum search function, last Buyback thread was in 2019 and it seems topical as the economy gears up.

Story time: I had a holding of Tesco shares. When I heard they were planning a buyback ("handing back cash to investors", as the mainstream and even specialist press universally put it), I bought some more before the XD date, sat back, and smugly waited for my payday to roll in. What happened next is that I was relieved of a number of my shares and got money in return - exactly what it says on the tin, in all fairness. I was struggling to see the exciting or profitable element of the situation, as this is exactly the same liquidation I could have done myself at any other time of my choosing. Noting that the share price was now lower, I consoled myself that I could buy back in, and if I ended up with a larger number of shares - each of them now representing a bigger slice of the pie - I would be better off in some sense. Between the buy/sell spread and a few quid commission, I actually ended up with fewer shares than I had started with. Hopefully, with fewer shares in circulation, future dividend payments will be bigger - at least that's the hope I'm clinging to here, in addition to plain old growth. Slightly nonplussed, I shrugged and went on with my life.

What is slightly worrying for me is the number of other companies now cheerfully promising to "return cash to shareholders" in this way. If they have excess cash on hand, I would far prefer them to just pay a special dividend, rather than messing around with these contrived and slightly sleight-of-hand style consolidation and buyback schemes. Am I wrong to feel this way? Or is my cynicism justified?

george4064

The share buyback you experienced with Tesco PLC was treated as a corporate action whereby the share buyback was rolled up with a capital consolidation event. Affecting all shareholders, 15 new shares were exchanged for every 19 shares held, hence reducing the number of shares available so that each share owns a higher % of the company and therefore will increase in value.

That contrasts to typical share buybacks, where companies will buy shares from the open market via market makers from cash in the bank and then cancel those shares so that there are less shares in circulation so in theory each share owns a slightly higher % of the company than before the buyback and hence worth a bit more.

For UK listed companies, they may prefer share buybacks rather than dividends because they are more flexible and not seen as ‘fixed’ as dividends are. Dividend figures are widely reported and scrutinised whereas share buybacks fly below the radar, so to speak.

So for a company to cut or cancel its dividend would be seen as a greater negative than if they scaled back or cancelled the planned share buybacks, hence companies may prefer the more subtle and flexible method of returning capital via share buybacks than dividends.

EthicsGradient

Actually, the Tesco action wasn't a "buyback" at all. It was a special dividend and a share consolidation (and that you point to an XD date is a big clue to that). Thus the dividend was subject to income tax for anyone holding it outside a tax shelter, and there were no capital gains as a result - which a buyback could involve (but, of course, only for the shareholders who choose to sell). The consolidation was just a bookkeeping exercise to keep the share price looking about the same (unnecessary work, in my opinion). As george4064 says, a normal buyback is an ongoing operation in the markets that should increase the share price, gradually. As far as I'm aware, Tesco is not currently doing this.

In the light of that, it is real buybacks the OP objects to, or is it special dividends after all?

Thrugelmir

Tesco was in effect a return of capital to shareholders. Sold a business (operation in Thailand) and had no use of the cash generated. By returning the cash and reducing the issued share capital the market value of the business fell. As Thailand no longer exists they'll be no profits to distribute in the future from this source.

US companies have a propensity to use share buybacks to soak up share issuance from employee and management remuneration schemes. Also where founders start offloading their personal holdings e.g. Jeff Bezos.  The ability to soak up shares results in the illusion of improving EPS year on year.  

Some investment trusts adopt a similar mechanism to Tesco's. To restrict the value of assets under management.  A capital redemption exercise is undertaken to return excess capital to shareholders. Rather than pay the cash as a dividend. 

Companies also borrow to fund buybacks. Not necessarily funded through free cash flow. Interest on the debt being tax deductible. Did read an article some months ago which raised the suggestion of altering the tax rules in the UK for companies above certain thresholds to restrict the deduction. That way removing the distortion it causes. Resulting in shareholders interests  being realigned with the management's remuneration plan objectives. 

Prism

US companies have been using buybacks along side or instead of dividends for many years now, as have a number of UK companies. It seems more popular going forwards. As an example, BP is not fully bringing its dividend back after last years cut but has instead said it would use more buybacks as a way of returning cash to share holders.

Thrugelmir

Prism said:

 As an example, BP is not fully bringing its dividend back after last years cut but has instead said it would use more buybacks as a way of returning cash to share holders.

As an investor always wise to be cynical. 

trufflehunt

Actually, I'm pretty sure that in some countries, unsure about UK, share buybacks are, were, illegal.

They are/were considered to be a fraud on shareholders. 

The reasoning being that the buyback removes shares from circulation, and increases the value of remaining shares, ut not in any way pro rata. The performance of senior executives in corporations is often rewarded by lump sum payments, ongoing slaries, and here, the triggering of share options. All of these according to the 'success' of said executives in getting the share price up to a certain level.

In removing shares from circulation, the holders of those shares have been defrauded of what they could otherwise have expected.  The fraud is basically made by the corporations' executives on it's own shareholders.

Money_Grabber13579

A share buyback can also be helpful from a tax perspective, being able to utilise the annual CGT allowance and the rest being taxed at CGT rates whereas a dividend would be taxed at the potentially higher income tax rates.

EthicsGradient

trufflehunt said:

Actually, I'm pretty sure that in some countries, unsure about UK, share buybacks are, were, illegal.

They are/were considered to be a fraud on shareholders. 

The reasoning being that the buyback removes shares from circulation, and increases the value of remaining shares, ut not in any way pro rata. The performance of senior executives in corporations is often rewarded by lump sum payments, ongoing slaries, and here, the triggering of share options. All of these according to the 'success' of said executives in getting the share price up to a certain level.

In removing shares from circulation, the holders of those shares have been defrauded of what they could otherwise have expected.  The fraud is basically made by the corporations' executives on it's own shareholders.

A shareholder is not forced to sell in a buyback; so I don't understand what you're trying to say in the final paragraph. I'm also not sure what you mean by the value of the remaining shares not increasing 'pro rata'. Each remaining share is still equal to each other remaining share, so any increase is pro rata by definition.
Triggering of share options is pretty much the opposite of a buyback - it increases the number of issued shares.

Thrugelmir

Money_Grabber13579 said:

A share buyback can also be helpful from a tax perspective, being able to utilise the annual CGT allowance and the rest being taxed at CGT rates whereas a dividend would be taxed at the potentially higher income tax rates.

Share buybacks are in the main conducted by companies themselves in the open market. Not by means of shareholders tendering their shares back to the company for redemption. 

Money_Grabber13579

Thrugelmir said:

Money_Grabber13579 said:

A share buyback can also be helpful from a tax perspective, being able to utilise the annual CGT allowance and the rest being taxed at CGT rates whereas a dividend would be taxed at the potentially higher income tax rates.

Share buybacks are in the main conducted by companies themselves in the open market. Not by means of shareholders tendering their shares back to the company for redemption. 

Yes, but it’s one of the considerations which many companies will make when deciding be whether to buy back shares or pay a special dividend i.e. they will look at the profile of their investors and decide which will generally give them the most favourable treatment. Of course, it’s far from the only consideration…