When companies have a burning need to boost their stock price and/or have no organic growth opportunities requiring fresh investment, they do one thing: engage in stock buybacks (usually funded with recently issued bonds). We first warned about the dangers of such a "strategy" in 2012 [6], and most recently, earlier today the WSJ once again noted that "U.S. Firms Spend More on Buybacks Than Factories [7]."
The reality is that stock buybacks are great... as long as the stock price keeps rising. They are also great as long as the stock isn't so illiquid that once the sole buyer withdraws, be it the company itself or its CEO (in the case of Hanergy [8] using corporate funds) the stock crashes.
The real problem emerges when after sinking hundreds of millions, or more, in stock buybacks, the stock no longer keeps rising.
This is precisely what happened to KORS stock. As Dominique Dassault [9] points out, earlier today Michael Kors reported abysmal earnings which have lobbed a whopping 23% off the stock price and the market cap of KORS just today.
But it was not KORS' operational issues that were troubling: it is how much the company burned on stock buybacks. In KORS' earnings release [10]we read:
During the quarter, the Company repurchased 1,409,682 shares of the Company’s ordinary shares for approximately $92.0 million in open market transactions
This means in the quarter ended March 31, KORS spent $92 million supporting its stock ahead of what it knew would be an earnings debacle. It also means that its average purchase price was $65.3/share in Q4, or 40% higher than KORS' last trade at $46.50.
But that's not all. Last quarter, after authorizing $1.5 billion for stock repurchases, KORS reported the following [11]:
During the quarter, the Company repurchased 5,068,813 shares of the Company’s ordinary shares for approximately $399.9 million.
In other words, KORS' average price in Q3 was $78.9, a 70% premium to the current market price.
[12]
Combining the two quarters, we calculate that KORS spent $492 million to repurchase 6.5 million shares at an average price of $75.9, some $30 higher than current market levels, and a 63% premium!
Needless to say, any portfolio manager who had spent half a billion only to see his investment return -40% that same year, would have been fired long ago. But not KORS management team, the same management team which in Q3 made the following statement:
Joseph B. Parsons , Executive Vice President, Chief Financial Officer, Chief Operating Officer and Treasurer, stated, “We are pleased to have repurchased approximately 5.1 million shares this quarter. This action demonstrates the Board and management’s confidence in our ability to generate strong free cash flow and to achieve our long term growth objectives
Perversely he is somewhat accurate, but here is the full story: in Q3 the company generated $474 million in cash from operations, the most in years. Of this amount, it spent $125 million on CapEx and $400 million on buybacks.
That $400 million is now worth $236 million.
Perhaps that is why Mr. Parsons did not have any commentary about how "pleased" he was to announce a further $92 million in KORS buybacks : $92 million which at today's KORS stock price is worth $65 million today.
Said otherwise, of the $500 million KORS spent on buybacks in the past two quarters, it already has a paper loss of $200 million. Incidentally, KORS spent about $200 million on capex for all of fiscal 2014.
And that, in a nutshell, is what happens when stock buybacks go horribly wrong.
Expect to see just this outcome for increasingly more stocks who are only propped up thanks to billions and billions in repurchases by management, which does nothing but merely delay the inevitable day of reckoning when massively overvalued and artificially supported stocks finally meet gravity.
As for KORS, which should be repurchasing stock precisely on today's epic rout, it very well may do just that: as the company conveniently noted in the release:
The Company also announced today that the Board of Directors approved an amendment to its share repurchase program on May 20, 2015, at its regularly scheduled Board meeting, authorizing the repurchase of up to an additional $500 million of the Company’s ordinary shares and extending the program through May 2017. This increases the initial repurchase authorization previously announced in November 2014 to $1.5 billion, of which approximately $1.0 billion is available for future repurchases over the next two years.
KORS also noted: "Share repurchases may be made in open market or privately negotiated transactions, subject to market conditions, applicable legal requirements, trading restrictions under the Company’s insider trading policy, and other relevant factors. The program may be suspended or discontinued at any time."
A few more quarters in which the IRR on buybacks is -40% and something tells us the future of KORS buyback program may be in very serious jeopardy.
