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"Risky Business": Companies Are Now Funding Share Buybacks By Selling Bonds To Other Companies
One of this year’s key narratives has been the degree to which US stocks have benefited from a perpetual, price insensitive bid. By that we of course mean corporate buybacks, which one might fairly characterize as having replaced the monthly flow lost to the Fed taper.

The buyback bonanza shown above is of course sponsored by ZIRP. Put simply, when borrowing costs are close to zero and when the market has become completely myopic as it relates to assessing performance, it makes sense to issue debt and plow the proceeds into EPS-inflating share repurchases. Throw in the fact that the FED-induced hunt for yield has forced risk averse investors out of govies and into corporate credit and you have a kind of goldilocks scenario for corporate issuance and buybacks.
This all comes at cost. That is, you can’t simply keep leveraging the balance sheet to artificially inflate earnings. Eventually, some of the proceeds from debt sales need to go towards capex or wage growth or something that’s conducive to boosting productivity, long-term growth, and competitiveness. However, that simply won’t happen in a world governed by what Hillary Clinton correctly (yes, she has managed to get at least something right believe it or not) calls the “tyranny of the next earnings report.”
Once you understand all of the above, you can begin to see why a lack of market depth in the secondary market for corporate credit is so dangerous.

You have an environment that encourages record issuance and the proliferation of bond funds along with the now ubiquitous hunt for yield means any and all supply is promptly snapped up. But if those bonds ever have to be sold in a pinch, there’s no one home at dealer desks thanks to Volcker.
All of this would be bad enough as it is, but as WSJ reports, it’s exacerbated by the fact that companies are now funding their own share buybacks by selling bonds to .. wait for it.. other companies. Here’s more:
Companies reaching for better returns on their cash have found a new favorite investment—other companies’ bonds—and they are loading up.
Cash-rich companies like Apple Inc., Oracle Corp. and Johnson & Johnson are snapping up corporate bonds sold by highly rated companies such as Verizon CommunicationsInc. and Gilead Sciences Inc.
More than half of corporate cash held by U.S. companies this August was invested in investment-grade corporate bonds, a record, according to investment-software company Clearwater Analytics. Meanwhile, treasurers have reduced their companies’ holdings of more traditional investments such as U.S. Treasurys, commercial paper and bank certificates of deposit.
Companies are betting highly rated corporate bonds are safe repositories for cash that will pay higher rates than more traditional bank deposits or money-market funds. But they are also increasing the risk to an asset where principal protection is the priority.
If interest rates rise quickly, the value of their lower-yielding existing bonds could plummet. A major market disruption could also make it difficult for companies to sell their holdings if they need the cash. Either could lead to write-downs or actual losses if they sell at lower prices than they paid.
For now, treasurers are figuring the bet isn’t that risky. Companies’ balance sheets are in good shape, and buyers are focusing on bonds that mature within five years, which carry lower risks than bonds that take longer to mature.
“To get more return, you have to take more credit risk,” said a treasurer at a large technology company that has actively been buying corporate bonds.
Well yes, and to be sure, when companies are flush with cash it's important to figure out how best to invest it, but then again, you now have corporate Treasurers talking like sellside credit strategists and needless to say, when you're buying all kinds of corporate bonds at the tail end of a credit supercycle, you're liable to get burned badly (on paper anyway) if and when rates start to rise.
Of course companies should also consider what would happen in the event of an economic meltdown. After all, the very same conditions that would lead to a downturn and force corporate management teams to raise cash will also serve to make the secondary market for corporate credit even more illiquid than it already is. In other words, if you think there's a dearth of buyers now, just wait until someone hits the panic button and when the firesale starts (likely after someone at a Vanguard or a BlackRock tries to transact in size to meet a wave of redemptions), corporate treasurers will find themselves in a decisively unenviable position.
We close with the following from Harvard's Victoria Ivashina:
“This is a risky business. Can they get it wrong? Absolutely they can get it wrong.”
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Non stop lols from the business community these days. If the economy so much as farts too loud right now, the massacre will be swift and ruthless. Expansion of credit risk is the new capex.
This will not end well.
Im no expert on this, but aren't they essentially turning into a kind of investment bank? buying billions in other companies bonds? so if you own apple stock, your stock and dividends performance is no longer based on if apple sells a lot of phones/computers, but the performance of a bunch of other companies and the interst payments, etc, on those bonds.
They are really getting creative in their can-kicking, ill give them that
The goal is to connect all corporations into one giant monopoly corporation.
Just call the Dr., he'll know what to do.
Calling Dr. Howard, Dr. Fine, Dr. Howard.
Calling Dr. Howard, Dr. Fine, Dr. Howard.
People think .gov is in trouble when interest rates rise. Public corporations are in deeper dog shit.
Snakes eating their own tails.
As soon as NIRP comes knocking at the door, i'd like to buy this buyback etf.
http://www.barrons.com/articles/stock-buybacks-too-much-of-a-good-thing-...
Stock Buybacks: Too Much of a Good Thing
Hedge fund activism has fueled stock buybacks, but skepticism is growing over repurchases—especially since they benefit short-term investors.
By Sarah Max
September 26, 2015
In the past 12 months, companies in the Standard & Poor’s 500 have doled out nearly $1 trillion to shareholders in the form of both dividends and stock buybacks, the highest level since 2007. For years, hedge fund managers have been big proponents of this, even actively advocating for it. Now, though, they are viewing them with a more critical eye.
“Corporations have five things they can do with cash: Pay a dividend, buy back stock, pay down debt, make an acquisition, or reinvest,” says Bill Priest, the CEO and co-chief investment officer of Epoch Investment Partners. “If you can earn a return higher than the cost of capital, you should reinvest or acquire. If you can’t, you should return it to shareholders.” If the impetus for share buybacks is to create paydays for CEOs who have earnings-per-share targets, however, it’s another story. Those “are a distortion of effective capital allocation,” Priest says.
It’s not just the cash-flush companies writing refund checks. Roughly 75% of all companies in the S&P 500 paid dividends and bought back shares in the trailing 12 months, according to new data from FactSet. Another 65 don’t pay dividends but did do buybacks during that time. In aggregate, companies spent more on buybacks over that period than they generated in free cash flow. The last time that happened was October 2009.
Low interest rates have undoubtedly fueled the frenzy. As Wall Street Journal reporter Mike Cherney recently noted, companies have sold more than $1.2 trillion in corporate debt so far this year, and proceeds for some of the largest bond sales— Microsoft (ticker: MSFT), Qualcomm (QCOM), and Oracle (ORCL) among them—were earmarked for share repurchases and dividends.
“The way I think of it is, what is your cheapest financing—debt or equity?” says George Schultze, founder of New York–based Schultze Asset Management and a hedge fund manager focused on distressed equities. If a stock is undervalued and interest rates are as low as they are, he says, it makes more sense for companies to finance a reasonable portion of their balance sheet with debt rather than equity.
Not everyone agrees. In April, Larry Fink, the CEO of BlackRock (BLK), sent a letter to the heads of S&P 500 companies urging them to take a more measured approach. “With interest rates approaching zero, returning excessive amounts of capital to investors—who will enjoy comparatively meager benefits from it in this environment—sends a discouraging message about a company’s ability to use its resources wisely and develop a coherent plan to create value over the long term,” he wrote. And in June, Goldman Sachs strategists penned a note recommending that companies stop spending their cash on pricey buybacks when the money would be better spent on acquisitions.
JEREMY GRANTHAM, co-founder and chief investment strategist of Boston-based GMO, has also been a critic of payouts, especially those funded by debt. “The capital spending that is going on at this stage, six years into a recovery, is dismally low,” Grantham lamented in an interview with Barron’s. “Insufficient capital spending means less GDP growth, fewer jobs, and downward pressure on wages.”
Buybacks, and specifically those done on the open market, are most worrisome, says William Lazonick, professor of economics and director of the Center for Industrial Competitiveness at University of Massachusetts Lowell. Dividends reward long-term shareholders, while buybacks fatten the pockets of executives and reward short-term investors, he says. “Where there is a lot of buyback activity, there is usually a hedge fund” pressuring executives, adds Lazonick, who is studying the link between hedge fund managers and buybacks.
http://www.barrons.com/articles/stock-buybacks-reward-management-more-th...
Stock Buybacks Reward Management More Than Stockholders
S&P 500 companies have accelerated their share-repurchase activity. Buybacks often boost quarterly earnings, but hurt capital investment.
By Mike Hogan
September 26, 2015
Here’s one more thing to worry about as earnings-reporting season approaches: Stock buybacks might be inflating earnings per share at a variety of companies. That suggests trouble for stocks when the buyback binge eventually ends.
In recent years, many U.S. companies have used their considerable cash holdings to repurchase their own shares, rather than invest in capital assets. The trend, which has accelerated in the past two years, means buyback programs are having a material impact on earnings per share, reports Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
“Share-count reduction continued for the sixth consecutive quarter,” Silverblatt says in relation to second-quarter earnings. “One in five companies reduced year-over-year [share] count by 4% again, thereby giving a much-needed 4% tail wind to EPS.”
S&P’s Website has updates on buyback data and many other market trends.
Buybacks have become “much needed,” as Silverblatt puts it, because corporate revenue and organic earnings growth have been slowing for several quarters.
Another worrisome trend: S&P companies have increased the share of operating earnings paid out as buybacks and dividends to more than 80% in most quarters, and 104% in the first quarter of this year. Yes, companies distributed more money than they earned in the quarter, most of it via buybacks. The payout ratio fell to a still-high 98% in the second quarter. But how to increase future handouts if you are proceeding to empty the corporate wallet?
Things haven’t yet reached crisis proportions. Collectively, Standard & Poor’s 500 companies account for about 80% of the market’s capitalization. In the main, they have solid balance sheets, and are sitting atop a ton of cash. The risks lie in individual index members and non-S&P companies with poorer financials.
Shareholders usually welcome buybacks, believing they lift share prices. And they do in the short term, says Silverblatt, noting that fewer shares outstanding are preferable to dilution. But the timing of buybacks is entirely at management’s discretion, and other factors also have a large effect on shares prices. Thus, it is hard to anticipate the trade. In the longer term, the benefits of repurchase programs are open to question, especially given management’s tendency to buy at market highs rather than lows.
Companies often buy shares to offset the impact of the exercise of employee stock options, explains Silverblatt. Doing so can also help to prevent a decline in the share price below benchmarks that determine management compensation.
Returning repurchased shares to the corporate treasury instead of retiring the stock doesn’t reduce share count, however. Indeed, total S&P share count grew 8.2% between the second quarter of 2008 and the same period in 2015, despite the expenditure of $5.57 trillion on share repurchases.
WHATEVER SALUTARY IMPACT share buybacks might have, they help to dress up the financial values and ratios by which quarterly performance is measured. Distortions extend past EPS to every ratio involving a per share calculation, as explained in this Investopedia article: “How Buybacks Warp the Price-to-Book Ratio” (http://www.investopedia.com/articles/fundamental-analysis/08/buybacks-vs...). Investopedia has links to many articles that explore lesser-known aspects of buybacks.
I don't understand this concept of stock buybacks. If the company has so much surplus cash, it would make more sense (imo) to raise the dividend. If a stock like IBM had an 8% dividend, people would be mortgaging their houses to buy shares of it. Instead of the company getting ripped off by overpaying for stock, retail investors would be the ones overpaying for stock.
Spungo - a couple of points
A. A lot of companies are not even funding share buy backs with cash but with borrowed money. In truth, alot of corporations are doing the same trick to fund dividends. Even huge cash flow monsters like Apple have borrowed big sums to fund buy backs due to majority of their cash being trapped over seas. In order to bring it home, they would owe 35% tax to satisfy IRS.
B. Raising the dividend a lot higher instead of share buy backs *could* be a great plan. But, dividends need to be met with sufficient future cash flow to keep it going. It's generally poor form for a corporation to jack up a dividend by say 400% only to have to cut it in half a few quarters later. A lot of investors are savvy to corporations playing tricks with dividends and will analyze free cash flow to dividend payout over the last couple of years. A company who is edging up near 100% (or more) of FCF to fund the dividend is a big red flag for dividend growth investors to avoid.
Generally speaking, corporations are rewarded more for having a history of increasing dividend payouts over many years rather than constantly trying to max out dividends any given quarter. Many investors are constantly looking at the list of 'Dividend Aristocrats' (those who have paid out a rising dividend without cuts for the past 25 years or more) to pick a stock to buy next or add more shares. Investors value the consistent and dependable dividend payout over any flash in the pan high payout followed by a big cut.
How much fraud could a fraudster fraud if a fraudster could fraud fraud?
Ask their accounting "team"?
17.
ZIRP = quicksand
NIRP = tar pit
Publicly traded corporations = dinosaurs
Succinctly put.
Extinctly put too.
Shades of 1929
If interest rates rise quickly...
the wsj make me raff out roud
rhinoceros, imposseros! [/cowardly lion]
Hmmm, corporations buying each other's promises with more promises. Sounds like a sure-fire winner to me. Of course, I've been out of the promises market since 2005. Sleep so well every night. Just didn't expect the financial hurricane to be so big and so slow-moving. But that's okay. Haven't talked to a money manager for ten years. That's why they hate physical gold and silver. No monthly commissions, to say the least; and not being able to re-hypothecate, front-run, use my holdings for their gambling collateral, etc. etc. etc. Thus, no income for them.
Risky Business https://www.youtube.com/watch?v=bodVVtqmbZE
I'll fund your buyback if you'll fund mine. Kind of like sucking each other's dick. We'll call it the homosexual 69 recovery!