Where The Levered Corporate "Cash On The Sidelines" Is Truly Going

Tyler Durden's picture

We have long been pounding the table on what in our view is the biggest detriment to any future growth for not only corporate America, but the entire US (where, sadly, government investment IRRs just happen to be negative - a fact that most won't understand until it is too late, especially not self-anointed economic wisemen whose only solution to everything is "do more of the same" yet who thought the utility of the Internet would be eclipsed by that of the fax machine): the complete lack of capital expenditures at the corporate level, and lack of (re)investment spending.

This was explained extensively previously here, and even the WSJ finally caught on to what is the most disturbing trend over the past "New Normal" 4 years. What was also explained, is that instead of investing in CapEx and hiring, or said otherwise, real sustainable future growth coupled with benefits for workers and consumers, companies have little choice but to pursue shareholder gratifying, short-term IRR boosting "projects" like M&A, dividends and buybacks, or else feel the wrath of scorned shareholders who will simply dump said prudent company's stock and move on to the next company which is more generous with its declining cash flows, and puts shareholders above all.

This is summarized simply on the chart below.

It turns out that, however, that there is more to the story, and as the following chart from SocGen's Albert Edwards shows, not only are companies using up what actual free cash flows they have for such stupid stock boosting gimmicks such as harebrained M&A (just look at the recent fiasco between HP and Autonomy to see how rushed M&A always ends), and of course buybacks, but they are now levering to the hilt to do even more of this. Think Spanish and Italian banks using repoed ECB "equity" to buy back not only their but their sovereign's bonds. The last time they did this? The golden days of the credit bubble.

The chart above also shows the rise in bank lending in recent months: it is not going to retail borrowers for such trivial Uses of Proceeds as buying houses. It is going almost exclusively to IG and high-HY rated companies to pursue buybacks.

This is how Albert Edwards sees the problem in a note relased today:

The charts below show the source of this recent recovery in bank lending to the private sector. It is clear that loans to the industrial and commercial sectors (dotted line) have been the key swing factor over the last two years for driving overall bank lending.

 

It is also notable, looking at a longer term chart, how small bank lending to the industrial and commercial sector is relative to the real estate related and consumer category, the former being some 3x larger. Yet despite the moribund lending activity to the real estate and consumer lending, the total aggregate lending data looks healthy as a cyclical recovery in corporate borrowing drives the aggregate data higher (see left-hand chart below).

 

But what are companies doing with this extra borrowing? They certainly don?t seem to be spending it on investment, which has been plunging.

 

And therein lies the rub: neither organic cash flow, nor incremental net debt issuance (not gross, as the balance merely goes to roll over maturing debt and to refinance the capital structure into a cheaper cost of debt) is being used for "invesment, which has been plunging." It is instead being used to fill the void created by Bernanke's ZIRP, now that equities have to be the new debt and provide the return to investors once obtained from fixed income.

So while we have beaten this particular dead horse to death many times, here it is straight from another horse's mouth, how in not so many words, Ben Bernanke's policies are actively destroying America's Corporate capital base, and are setting the stage for an epic collapse in Return on Assets, if not so much Return on Equities in the CapEx-free years to come:

So on this data the corporate sector is borrowing heavily, both in the markets and from the banking sector, to suck up their own stock at a 4% annual rate ?albeit not as heavily as in 2007 or 1987. So to that extent, Helicopter Ben?s approach of printing money to drive asset prices up actually seems to be working! Newly printed money is clearly finding its way into the hands of willing corporate buyers of equity via the banking sector.

 

Putting aside for one moment just how lunatic a policy this is (already tried and tested between 2001 and 2006), we think corporates borrowing by the bucketful to buy in their own equity will end badly -? it always does! I finish this note with an insightful, more bottom-up analysis of this practice from my Quant colleague Andrew Lapthorne.

 

Andrew wrote, ?Of course, there are some perfectly sensible reasons put forward by corporate financiers for swapping today?s expensive equity (i.e. cheap from an investor?s point of view) for cheap debt (record low yields), especially given the ability of many corporates to issue 20+ year bonds plus the incentive that interest payments currently remain tax deductible.

 

We know that buybacks are contrarian indicators, occurring at the top (and not the bottom) of the market. Why, we ask, are companies leveraging up now and not 12 months ago, when equity prices were much lower? We conclude that (contrary to what we read), US dividend payments are not enjoying a revival relative to cash flows and that buybacks remain the distribution channel of choice for corporates wishing to boost EPS and limit the effects of option dilution. Indeed, some of the biggest US names have issued debt to pay for buybacks (Home Depot, Microsoft, Amgen, Hewlett Packard, McDonalds, DirectTV, to name but a few) but there are also firms in Europe that have been doing the same (Siemens, Telenet, Adecco). In the current economic climate, you may find this surprising ? we do too! A buyback in this form is not a return to shareholders ? it?s called gearing or balance sheet risk and will come to haunt some firms when the economy enters a downswing.

 

Andrew shows just how awful the timing of companies buying in their own equity has been historically. Often the corporate sector ends up as the only major buyer of stock near the peak of the market and then switches to issuing as the market crashes. This inevitably has exacerbated the equity boom and bust in recent years. And as pension funds now cannot tolerate the 50% plus draw-downs of the last decade, it can also be said that this corporate finance zaitech has contributed to the death of the cult of the equity, where equities once totally dominated the portfolio of most pension funds.

 

But can this time around be different? I seriously doubt it. When the next leg in the ?structural bear market? occurs, expect the equity buybacks to end, contributing to a renewed steep downturn in bank borrowing and monetary aggregates. The recent surge in the money data should be seen as a sign of the ills in the US economy, not health!

We could not have said it better.

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mayhem_korner's picture

 

 

The alternative is not to buy back shares held by shareholders, irrespective of dividend policy.  All these clowns are doing is taking the returns generated from 100 shares of invested capital and expressing them over 90 (or some other post-buyback number).  Simple shrinkage of the denominator makes things like EPS look larger.

Speaking of shrinkage...

http://www.youtube.com/watch?v=1cUNNKzj_Nc

mayhem_korner's picture

 

 

Buy backs are desperate attempts to try to improve the optical illusion of actual returns.

Here's my summary: (1) printing of Bernanks props up equities out of the need to park the liquidity largess into something, (2) pant-pissing corporate execs double down on the faux stock prices with buy backs, and...wait for it...(3) the combo of (1) and (2) fail to keep pace with the yield on gold & silver.  The moral: stack on!

walküre's picture

Really? Does Wall Street really like buy backs? When the execs of pubcos. take on debt to purchase their own newly freed up shares, than that is theft of productivity. The execs are leverging the pubcos. in order to write their own paycheques. The leveraged pubco. is more vulnerable to takeovers and less likely to survive in a downturn.

Ask the workers if they'd prefer their execs taking on corporate debt to buy their own shares or give the workers a raise?

SMG's picture

Everything seemed normal, like it was all going to be okay.  Things had seemed fine for years, it was like it could go on forever.  And then one day it happened, the day that changed everybody's lives.  What had we done?  How could we have been so irresponisble, neglectful, and ignorant?  Why did we let the criminals do this to us? 

Now we must all suffer, but we will survive this, and we will never let this happen again....

Winston Churchill's picture

Tell that to the  buyers reinflating the housing bubble.

All be the same in a hundred years.

Bah Bah.

walküre's picture

How much equity are these buyers actually putting into the places they're "buying"? Are they building equity?

That ship has sailed. The new buyers are ear-to-ear in debt and make minimum payments on everything they can get financed. Based on that, they cannot build equity unless we see hyperinflation of all assets and leave the debt principals in the rearview mirror when it takes off.

How do we get there?

camaro68ss's picture

did someone from Rome say that?

Big Slick's picture

"... and we will never let this happen again"

Human history says that notion is wrong.

by Kipling... http://www.kipling.org.uk/poems_copybook.htm

The Gods of the Copybook Headings


AS I PASS through my incarnations in every age and race,
I make my proper prostrations to the Gods of the Market Place.
Peering through reverent fingers I watch them flourish and fall,
And the Gods of the Copybook Headings, I notice, outlast them all.

We were living in trees when they met us. They showed us each in turn
That Water would certainly wet us, as Fire would certainly burn:
But we found them lacking in Uplift, Vision and Breadth of Mind,
So we left them to teach the Gorillas while we followed the March of Mankind.

We moved as the Spirit listed. They never altered their pace,
Being neither cloud nor wind-borne like the Gods of the Market Place,
But they always caught up with our progress, and presently word would come
That a tribe had been wiped off its icefield, or the lights had gone out in Rome.

With the Hopes that our World is built on they were utterly out of touch,
They denied that the Moon was Stilton; they denied she was even Dutch;
They denied that Wishes were Horses; they denied that a Pig had Wings;
So we worshipped the Gods of the Market Who promised these beautiful things.

When the Cambrian measures were forming, They promised perpetual peace.
They swore, if we gave them our weapons, that the wars of the tribes would cease.
But when we disarmed They sold us and delivered us bound to our foe,
And the Gods of the Copybook Headings said: "Stick to the Devil you know."

On the first Feminian Sandstones we were promised the Fuller Life
(Which started by loving our neighbour and ended by loving his wife)
Till our women had no more children and the men lost reason and faith,
And the Gods of the Copybook Headings said: "The Wages of Sin is Death."

In the Carboniferous Epoch we were promised abundance for all,
By robbing selected Peter to pay for collective Paul;
But, though we had plenty of money, there was nothing our money could buy,
And the Gods of the Copybook Headings said: "If you don't work you die."

Then the Gods of the Market tumbled, and their smooth-tongued wizards withdrew
And the hearts of the meanest were humbled and began to believe it was true
That All is not Gold that Glitters, and Two and Two make Four
And the Gods of the Copybook Headings limped up to explain it once more.

As it will be in the future, it was at the birth of Man
There are only four things certain since Social Progress began.
That the Dog returns to his Vomit and the Sow returns to her Mire,
And the burnt Fool's bandaged finger goes wabbling back to the Fire;

And that after this is accomplished, and the brave new world begins
When all men are paid for existing and no man must pay for his sins,
As surely as Water will wet us, as surely as Fire will burn,
The Gods of the Copybook Headings with terror and slaughter return!

Dr. Engali's picture

They should be buying something tangible instead of wasting it on equity. They can prop the ponzi up for a while but eventually they will have no cash to survive.

RopeADope's picture

I think you meant to say they will have no earnings to survive. The monetary socialists will make sure they have plenty of cash even if it means air dropping it from Antonov AN-225 cargo planes around the world.

RopeADope's picture

So you are saying FASB 142 which was implemented at the real earnings peak was a way of enabling theft of shareholder capital on the downcycle without having to tell anyone?

 

And here I thought M&A activity during contractions was a good thing...

mayhem_korner's picture

 

 

I'm filing for the copyright on the term "leveraged buybacks."

 

walküre's picture

You got the idea. Speaking of canibalism. Did you see the pic of Romney pumping his own gas just minutes away from his $12 million mansion. He and the wife went to see that latest vampire flick. Few things didn't add up during the campaign either.

Liquid Courage's picture
Herbert Spencer....... "The ultimate result of shielding men from the effects of (their) folly is to fill the world with fools."

Me.......  The ultimate result of shielding thieves from their just desserts is to fill the world with thieves.

ebworthen's picture

So many parallels to 2007-2008, and there is even less money and more debt this time around.

Share buybacks of the FED inflated cotton candy markets.

Brilliant.  Bailout insurance mechanism.

And bonuses of course...

Cursive's picture

Rule #1 of being a CEO:  You don't have to know anything about your company's business, but your career/life depends on your company's stock price.  Defend at ALL COST.  That is all.

NoDebt's picture

Bingo.  That's the answer that rings the most true.

Short-term thinking pervades as much now as it did before the crisis.  Why?  Why think only short term when you know it will cause trouble in the long term?  The answer is pretty simple, I think.

LONG TERM DOESN'T EXIST.  THEREFORE, NO REASON TO PLAN FOR IT.

You think it's only ZH'ers who recognize the shit storm heading our way?  Are we the only ones wise enough to see the folly?  Doubtful.  Plenty of others can read the same tea leaves.  They're running around gathering up as many nuts as they can before it hits.  What the world looks like afterwards is anyone's guess.  THEN we'll develop a plan.  No point in doing it now.

 

 

 

adr's picture

Evidenced by the CEO's average salary vs net worth in stock. To be worth $50 million a year in salary, a company would need to sell a lot more stuff. To be worth $50 million in stock per year, you just need Cramer to yell BUY, BUY, BUY!!!!

Unprepared's picture

Debt overhang makes positive NPV investment projects less attractive for management to pursue, as any future cash flows generated from said projects would disproportionally benefit bondholders while the risk is bore by shareholders (and management by extension).

 

The result is management engaging in self-sabotaging behaviors and zero capex. In such environment, it makes "sense" for both management to just keep borrowing/rolling over existing debt to increase stock prices/dividends at the expense of organic growth and future profitability prospects.

Piranhanoia's picture

answer;   Vegas, Macau, Monaco,  3 card monty.  Investing is only gambling after all.  Everyone thinks they have a system to beat the rigged wheel of fortune.   I'm going to spend 10K on lottery tickets today because my system can't be beat.  I play all the numbers or none.

Abraxas's picture

I designed a great system for myself, but I haven't followed through, so I lost... that is, I lost financially, and my Ego got deflated, but I learned a lesson in humbleness and humility. These are the qualities this country needs the most and desires the least.

RopeADope's picture

I remember an Australian investment fund back in the 90's that had a 100% chance of winning a big California lottery jackpot. They bought every ticket combination possible so were guaranteed in their minds to win the pot (netting a small profit)

 

I believe they ended up splitting it with 7 other winners...

banksterhater's picture

It's Bernancke's CRIMINAL OPERATION of NIRP allowing these TRAITOR CORPORATIONS to issue junk debt for buybacks, etc, we know that was the top last credit bubble.

walküre's picture

He had to satisfy the crooked execs because they know what the Fed is doing and they want their piece of the action. The revolution will deal with crooked bankers and greedy executives. Both groups are equally responsible for the demise of America and the impoverishment of the masses.

Downtoolong's picture

Because, risk is so much easier to hide than dollars and cents.

Whiner's picture

I can't figure out how long it will be befor the world wide finacial collapse (and war to grab brown men's assets). 400% world debt to GDP, 600%?Even with perpetual near-zero rates and sovereighn/bank refis, she should hit a deflationary bang moment well before end of Obammy's term, followed quickly by a rush to commodities which will trigger rampant inflation. Not trying to time her or project magnitude of end game, just buying PMs and energy on the dips. Bank runs come like a thief in the night, so cash keeping is problematic. Ramping up % of PMs.

adr's picture

It keeps going until Bernanke has to turn off the presses. By that time it will already be too late to prevent the collapse.

As long as corporations don't have to sell actual product to enrich shareholders, this game will continue. The true product of corporate America today is paper fraud.

dexter_morgan's picture

FORWARD!!!

F.M.D., Jr.

Confundido's picture

This guy foresaw this situation back in March, after the LTROs enables USDs to flood back to Europe, and keep funding the party: http://sibileau.com/martin/2012/03/04/

orangegeek's picture

SP500 weekly shows substantial downside.

 

http://bullandbearmash.com/chart/sp500-weekly-trend-continues-losing-15/

 

All the games are being played to keep stocks up while insiders exit their positions - exit positions but not crash the market in the process.

adr's picture

Directors and CEOs are using essentially free corporate debt to funnel cash right into their hands, while the company is buying back shares, they are printing and selling their own. During buybacks insider sales have been enormous.

Reminds me of the scene in Men Who Built America where the two railroad guys were printing shares using a printing press in their office, while Vanderbilt was buying up every share he could. The guys were just sitting their laughing. Later that night they toasted to money, Vanderbilt money.

I see CEOs and directors sitting over $200 plate dinners in NYC toasting to money, Bernanke money.

 

Once again you don';t actually have to sell anything to become filthy rich anymore. Sure it is just FIAT, but until the paper becomes worthless you can buy anything you want, including stores of wealth that will still be worth something after the collapse. Every convicted counterfeiter should be set free, they did nothing compared to nearly every CEO in America.

Waterfallsparkles's picture

Net Flix was notorious for this.  The Company would Buy Back Stock the day before the Reid Hastings the Ceo would Sell his Stock Grants.

So, it is true that Companies Buy Back Stock in many times for CEO's and Exectuives to Sell at the highs.  Just like Net Flix.  Net Flix Bought back many shares in the $290. to $300. range.

steelhead23's picture

So, Mr. CFO, you squandered all your company's operating capital and endebted our fine company, all in an effort to prop up stock prices.  And you personally cashed a bunch of your stock options at the same time.  With the market declining and sales in the toilet, how sir, does your past actions comport with your fiduciary duties.  Please have a detailed explanation, or your resignation, on my desk by noon today.  The Boss.

adr's picture

Like the boss didn't tell the CFO to do it.

walküre's picture

What needs to happen is that the productive part of the company (a.k.a. the workers) organize (a.k.a. the union) and put all the execs in one room and spank them. Then kick their asses to the curb, declare their stock shenanigans a crime and the corporate debt odious. Do that in a number of large American corporations and see who is BOSS.

All that paper is worthless at best and illegitimate at worst. It doesn't exist. It's the figment of somebody's imagination which has become propaganda.

The reset will know no mercy and the paper millionaire will have to work like everybody else just to survive.

brettd's picture

And Litt'e Timmy and Uncle Ben are telling the C-suite to do it too!

monopoly's picture

Albert Edwards has a lot of balls posting truth. Not sure if he will be around much longer. Oh, will we ever see the end of all the lies, deceit, theft of our once great nation. Or will end up as a banana republic as so many great powers have in the past?

Quinvarius's picture

Hey!  Guess what?  My 85 billion dollar a month QE/ZIRP gorilla has your credit cycle gibbon in a headlock.  Stocks move on easy money.  It is the law of the land.  All who break the law are penalized severely. 

woggie's picture

the beast is on the gobble and all that matters is we're all headed for it's belly
http://youtu.be/ntmthFyaYzY

q99x2's picture

Golden days of the credit bubble. Something doesn't seem right that the Government should pay people to study Hamlet and Chaucer. Even though it is exciting that it wasn't a beard and all I do not believe this can go on. Maybe I'll be graduated by then.

Nobody For President's picture

Paying people to study Hamlet and Chaucer beats the hell out of (and is a lot cheaper than) blowing up brown people with turbans in far-off countries.

Titus Flavius Caesar Vespasianus Augustus's picture

Kidding aside, why would anyone invest in stocks or bonds right now when there's so much gold, silver, bullets and seeds to be had?

 

 

Mitch Comestein's picture

Why...because what if I am wrong.  What if my gold gets confiscated or stolen; this is coming from someone who have 60% in gold coins.   Bullets are in a bubble.  Seeds....who the fuck buys seeds!  They are like that "newly discovered cash of rare coins... that are always being sold on the radio.

Aurora Ex Machina's picture

I realise this isn't the correct thread for this observation, but something I've been tracking.

Wednesday, November 07, 2012

With the economy slowly recovering, infrastructure investment will help spark growth and continue our path towards prosperity. In 2009, ASCE gave America’s infrastructure a “D-“ grade and called for $2.2 trillion in investment over the coming five years. Obviously, this investment has not been made, and consequently, we have jeopardized our economy, our quality of life, and our very safety. We are pleased, however, that Congress this year passed and the President signed the Moving Ahead for Progress in the 21st Century (MAP-21) legislation that reauthorized the nation’s surface transportation funding.

April 2010 ASCE papers

Media friendly explanatory videos, 2009

(ASCE = American Society of Civil Engineers)

 

Given Sandy (and the engineering papers ZH linked to outlining how $5-6 bil could have off-set a significant chunk of the damage costs), and a potential marriage of interests between; a) ASCE / ivory tower interest, b) Insurance Industy / hurting Construction industry, C) Government looking to employment data / downturn and D) Hawks looking to maintain competitiveness with China, there seems to be at least some chance of a "hail mary", $2.5 - 3 trillion stimulous package. Looking back on 9/11, I remember a similar vibe. 

I'm happy to be schooled in why this won't be appealing to Obama / Congress, but with the fiscal cliff, is there any reason not to double-down for a Krugman epic spending spree?

 

Disclaimer: I need to dig out MAP-21 first to take a look at the proposals. Those who need their frog-pills, now commence comparing it to Agenda-21...

pitz's picture

At least the Civil Engineers build shit.  The bankers just build pyramids of paper (or these days, their electronic equivalents!).

Aurora Ex Machina's picture

Yes, that was the hidden dagger, in my little velvet glove.

If you're committed to "QE to infinity", why shove it into CEO's pockets, when you could be actually strengthening your internal economy? APPL has $100 bil in their hedge fund (close), do they really need more to ship off to Chinese Robots? If you're committed to a fiscal policy like that, don't pretend you're actually playing market Capitalism, just go for something that might actually benefit people.

 

(Oh, and, I'm sure everyone knows this already, but AMZN just spent ~$770 mil ish on Robots - after 10 years, AMZN might make some profit, and the turn to full automation now comes to America. Foxconn, now Amazon. Expect slaughter on the high-street come Monday, esp. if Black Friday turns into Walmart getting a taste of worker's ire)

brettd's picture

Alas, the government tells the civil engineers:

I want you to spend a trillion dollars and put those people right back in the flood/fault zone!

Genius.

RockyRacoon's picture

That's not to mention the "military spending".   Without the wars we could have concreted over the entire continental US.   Not that that is a viable alternative -- Japan has been down that road already.   Your point is a cogent one in that, at least, there would be something to show for it other than fat bankers.