Macy's Massacre - 3 Years Of Wasted Buybacks Ends Financial Engineering Dreams

Macy's is down over 13% today, pushing towards a sub-$40 handle - the lowest since February 2013 - after lowering guidance and disappointing a market full of hope (and hype) that retail is back (remember, all the retail hiring last Friday). However, that is not the most prescient issue as 3 years of buying back billions of dollars of Macy's stocks - to financially-engineer earnings to ensure executive compensation is satisfactory - have been completely wasted. And worst still, the additional debt added to fund the total failure in timing of buybacks has now sent Macy's credit spiking to multi-year highs (as the stock tumbles).

"No Brainer" - Macy's actually increased their buyback pace last quarter alone - spending $900 million on stock at an average price of $53.89, a loss of $230 million of that "investment"


And the flipside of shareholder-friendly releveraging... spiking default risk...


Now what? This is the clear message that executives in every credit cycle - there is a limit to the largesse with which you can abuse bondholders in the name of levitating share prices amid a dismal reality.

As we detailed previously, if you needed further proof that US equity markets have become the preferred channel for transferring debt sale proceeds directly into the pockets of top management, Bloomberg has all the evidence you need. Here’s more:

Buybacks and dividends are rising to records in the U.S., and for many chief executives, that means a fatter pay check -- even if sales aren’t growing.


Eleven of the 15 non-financial U.S. companies that spent the most on buybacks last year base part of CEO pay on earnings per share or total shareholder return, or both, according to data compiled by Bloomberg. These metrics get a boost when businesses return cash to investors, giving companies like International Business Machines Corp. and Cisco Systems Inc. added incentive to dole out cash to stockholders.



Linking compensation to buybacks and dividends can encourage managers to sacrifice funds that could be used for long-term investments, economist William Lazonick said. It also raises the prospect that executives are being paid for short-term returns rather than running a business well.


Tying pay to performance has long been considered a shareholder-friendly move that gives executives an incentive to ensure that the company is on solid footing. Investors such as Warren Buffett have applauded payouts when they consider shares to be undervalued. Large pension funds have welcomed pay incentives, like when Walt Disney Co. in 2013 changed the way it calculates CEO Bob Iger’s stock awards.


Yet dividends and buybacks can prop up per-share earnings and total shareholder return -- lifting CEO pay as a result -- even in cases where sales are falling.


The focus on shareholder value has “led to this really corrosive feedback loop between executive compensation and corporate behavior,” said Nick Hanauer, co-founder of venture capital firm Second Avenue Partners LLC. “When everyone around a board room can justify essentially any behavior to generate a higher stock price, no stone shall go unturned.”



Average CEO compensation for the top 350 U.S. firms by revenue has climbed to $16.3 million last year, according to data from the Economic Policy Institute. That’s up from $15.7 million in 2013.


Overall in 2014, non-financial companies returned almost $1 trillion in share repurchases and dividends. As a percentage of gross domestic product, that’s among the largest payouts on record.


Not all investors are applauding the bonanza.


Amid a bull market, shareholders may not be as concerned as they should about the potential boost that buybacks and dividends can give to CEO pay, said Robert Barbetti, head of compensation advisory for J.P. Morgan Private Bank in New York.


“Boards and compensation committees should be thinking very carefully about the incentive plans and objectives that work long term.” 


As BloombergView followed up today, there is simply no question who really benefits in the end from management's exuberant buybacks: Why Management Loves Buybacks

According to RAFI's study, U.S. companies issued stock equal to $1.2 trillion last year. All told the new issues in 2014 exceeded share buybacks.


The RAFI study also found that "the cash flow statement often fails to report the majority of a company’s stock issuance.” Much of that unreported issuance is used as compensation for employees, primarily management. “When management redeems stock options, new shares are issued to them, diluting other shareholders” the report further notes. “A buyback is then announced that roughly matches the size of the option redemption. This facilitates management’s resale of the new stock."


The conclusion is that what looks like buybacks are actually thinly veiled management-compensation plans, or in RAFI's words, “simply a mirage.”

The poorly disclosed compensation structure is only half of the problem with buybacks. Timing and pricing are another big issue... as we showed above.

As Bloomberg concludes, the bigger question is simply this: Why is management at so many companies bereft of better ideas and more productive uses for corporate cash?

Maybe it's because so much of the proceeds of buybacks end up in their own pockets.

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Finally, do you still believe the huge surge in retail jobs in the payrolls data?


Charts: Bloomberg