… but based the number of potential “flavors” listed it’s safe to assume the total amount borrowed won’t be insignificant. “Big” is the consensus. $6 to $10b range on Finance Twitter. I’ll guess $12.5, just to be extreme.
These deals are starting to add up for Apple. From 2013 to the end of last year Apple issued $55 billion in debt to fund buybacks and dividends. The rates are low. The company can afford it. For now. So could IBM, back in the day. That hasn’t turned out so well.
I’ve been conducting a one-man jeremiad all year, including about Apple in particular here. The broader fin-media world is starting to pick up the story, as expected. They aren’t quit getting it right.
The issue isn’t what Apple has made or lost repurchasing Apple shares. Apple doesn’t gain or lose anything on their P&L for repurchased stock. No company does. The shares are retired. The problem isn’t that Apple overpaid but that $38b in cash has been laid out in the name of “returning cash to shareholders” since the start of last year and Apple’s stock has been a disaster anyway.
The only semi-justifiable reason for buybacks to using them to hide executive compensation. Remember, I said “semi-justifiable”. Share repurchases keep investors from getting diluted when executives cash out of stock option packages. That’s a good thing. It’s fair. A little oily, but fair.
Other than as a compensation dodge buybacks are economically indefensible. There is nothing wrong with Apple that can be fixed with a share repurchase. The stock is broken because the products are stale. As a long-term shareholder you’d rather they focus on fixing that problem than worrying about dilution.
Looking for some Saturday morning Doomsday Reading? Sure you are!
Start with my recent pieces on Buybacks. I continue to think the best shorts of the next few years will be merchants who have been issuing debt to buyback shares.
To sum up the basic theme: low-margin companies taking on debt to repurchase stock is dumb on the surface. The fact that it’s been sold to America as “returning cash to shareholders” is going to make us all look like fools in 25 years.
Mailbag on the math of stock buybacks (warning: this is a little wonky… it won’t hurt my feelings if you opt out now)
Amiable Reader writes:
Hi Jeff, love the article and financial insight. Just to play devil’s advocate (extra Pacino) for the moment, what happens if a company doesn’t retire its shares? I don’t believe it’s a requirement for them to retire their shares, but I could wrong on this. Does it depend on the buyback agreement? Would appreciate any commentary on this. Thanks in advance.
You can’t have your shares and buy them back too. If stock isn’t retired it counts for calculating EPS. Raising EPS (and the fallacious “supply and demand” argument) are the whole point of buybacks.
There are a number of accounting techniques for putting repurchased shares into suspended animation. As usual on Wall Street, the more you dig into them the more you realize they are complicated bc they are bullshit.
It’s pretty simple: If repurchased shares still exist as freely traded product they have to be counted for earnings purposes. That would make a company effectively long shares it could never sell; a purely speculative play by the BOD. No BOD wants that burden and history suggests they are right to avoid the accountability since boards’ timing is generally lousy despite literally infinite material non-public information.
But here’s the magic: if shares are retired they no longer have any tangible value that can be specifically footed to the trading value of other shares. Repurchased stock is dead and the cash is in the hands of the seller. Where once there was a liquid stock and cash there is now just cash. So half the previously existing economic value has been eliminated by the outstanding share count has gone down. Which is fine until you remember EPS isn’t a measure of financial health. Net income is. Long-term shareholders who seek long term value growth should threaten to burn down the HQ of any company even hinting at a repurchase.
What the company retains are debt load and interest payments. Companies very, very seldom flip from buying back stock to doing secondaries. Doing so would absolutely kill their shares. That means liquidity is restricted even beyond interest. So a buyback is financially tantamount to buying shares and lighting them on fire then paying an annual fine for pollution. If you’re lucky you’re interest rate paid on buyback loans is roughly equal to the dividend payments saved.
Companies are in a literal economic sense the worst conceivable buyers of their own shares.
In the short run there’s a case to be made for repurchases. Especially with the activist huckster salesmanship, having a company bidding for stock can give shares a boost. Which is exactly what you as investors don’t want to happen. You want dips. Those are buying opportunities. If I buy a dip I get to sell later, keep the profits and buy stuff. If a company buys its own dip it gains nothing (ex executives incented with EPS goals and stock options).
Competing with me in the marketplace for you own stock isn’t shareholder friendly. It’s bullshit. Buybacks steal investor profits in favor of nothing. Because, as we are be reminded this earnings season, there is 0 evidence that buybacks contribute to the longterm intrinsic value of a company.
By the time capital allocation f-ups kill a company the activists are usually gone. The exception is Berkshire where Buffett has chosen to keep the zombie shell of what used to be IBM on the books.
All you really need to remember is this: Every CEO bragging about how a stock has gone up during a buyback program is either an idiot or just begging someone like Warren Buffett to tell him he’s a good boy.
Last August during the China meltdown Apple CEO Tim Cook skirted SEC rules by sending an emailing to CNBC star Jim Cramer. The goal was reassuring investors.
Cook was talking his book. During the quarter ending September Apple spent $14 billion repurchasing its own shares at an average cost of $114. The company also completed a $6 billion “Accelerated Share Repurchase” last July, retiring 10m shares (listed below as part of a Q3 transaction but completed in July, per Cook himself during the Apple Q4 call).
During the last 3 months of 2015, in the quarter reported last night Apple bought $3b worht of stock on open market purchases at an average cost of just over $115 and yet another Accelerated Repurchase for $3b to get 20m shares on initial settlement. (For a good primer on why the average cost of accelerated repurchases is so much higher than open market transactions see this from the Motley Fool).
All of which would have been fantastic had Apple not discovered what the rest of the world already suspected: China isn’t great.
In his opening preamble Cook spent 2/3rds of the opening 750 words talking about currency, Chinese headwinds and the generally horrific turn the world has apparently taken since Cook emailed Cramer and launched an aggressive battle to protect Apple’s shareprice by throwing money at it.
“We’re seeing extreme conditions unlike anything we’ve experienced before just about everywhere we look” Cook said, all but ululating as he handed the media an almost perfect spotlight quote.
Cook went on to guide lower for the current quarter. Product shipments were a disaster on the iPad. Watch sales weren’t specifically disclosed (which means they are insignificant) and margins are a question. Currency alone swayed revenues enormously according to Apple itself. Those facts should pretty much eliminate the idea that companies in general, or at least Apple in particular, has a better guess than anyone else when it comes to their future results and share price.
The company says it has $216 billion in cash but that’s misleading, to be nice.
Apple has about $16.5b in US cash, $53b in debt and another $35b in non-current liabilities. 93% of Apple’s cash is overseas and it currently costs 40% to repatriate foreign earnings.
How do you value all that foreign cash? You have to discount it dramatically. If you assume Apple repatriates the money at full tax rates (40%) Apple has an amount equal to $136b in real value. If you assume Apple can keep skirting the repatriation problem by borrowing cash in the US against the foreign cash of indeterminable value you have to discount the money for the interest paid, at the very least.
All of which ignores all that currency trouble Cook was nattering about last night. If Apple gets paid in China when does the money become dollars? What if cash flows drop? IBM once thought it had plenty of cash for buybacks. It spent a decade spending cash on shares and missing opportunities. Now IBM has neither the money nor the ability to execute.
None of this matters to buyback fanboys, the most vocal of which being Apple shareholders. Here’s AppleInsider’s take on buybacks from last October:
The key parts there are the assumption that both shares and earnings will rise. Also, Apple executives are uniquely positioned to “fully grasp the potential of the company in the global markets it is operating across.”
Everything about this is wrong. More concerning still, Apple itself demonstrably has no grasp on what’s happening in China this year. Consensus estimates, the muddy bedrock on which buyback logic rests, are coming down as I type.
Rising debt, lower margins, uncertain earnings and a recent track record of buybacks utterly failing to help the shares. What’s the answer?
More buybacks, natch.
“We plan to be very active in the US and international debt markets in 2016 in order to fund our capital return activities.”
Selling Shares to the Least Efficient Buyer
Buybacks are the biggest scam since GreenMail. A company repurchasing shares is literally the least efficient buyer on earth. If you had $100 in cash yesterday you could have bought 1-share of Apple from me. Less the drag of transaction fees we would each still have about $100, or $200 total.
When Apple or other companies buy back stock they retire the shares. That’s the whole point. If Apple didn’t retire the stock the repurchased shares would drag on EPS. What’s more, the entire underlying assumption of buybacks is reducing shares outstanding will raise the price of the stock by an equal amount (which only makes sense if the market is efficient… and if the market is efficient there shouldn’t be “irrational” price drops in the first place).
The only buyer to get nothing out of Apple’s share appreciation since it launched its buyback program in 2013 is Apple itself.
The key to buybacks is that the shares outstanding disappear. So, unlike every other purchaser on earth Apple can’t practically sell shares purchased on the open market. Companies doing buybacks profit less than literally every other potential share holder when a stock rises.
If Apple buys my 1 share I then have $100 and Apple has 1 share which it immediately shreds. 50% of the total pie has been destroyed. Apple doesn’t get to count appreciation on repurchased stock. It means nothing to them. The cash and the stock are gone, all Apple has left are the interest payments. Just like John Law trying to stop the implosion of the Mississippi Bubble in 1720 Apple is effectively buying stock and lighting it on fire.
If the stock goes higher and earnings rise and cash flows stay robust that’s no problem. Should anything in that list not happen as expected the whole model falls apart immediately.
History will be unkind to the capital allocations made by corporate America during the era of free rates. As usual, individuals are the sucker at the poker table with the Buffett’s and Icahn’s of the world.
As I type we’re at 1817 on the S&P500. That’s below the neckline of a huge head and shoulders pattern. It doesn’t matter how you personally feel about charts. Incremental selling will be done unless by some hand of God and the Plunge Protection Team we close back above 1850.
In just a couple weeks the market has been kind enough to offer me grist for a brief course in Macke’s Personal Rules for Sell-Offs:
Here’s the core problem with Crude and Currency going crazy, boiled down as far as I can rend it, and why it might lead to the Worst. Year. Ever.
I think there’s a massive underlying problem with balance sheets. Cash has been thrown away buying back shares instead of making improvements in core operations. Both at Macy’s and IBM. Watch for this to become a bigger issue as margins get tighter and all that “cheap” debt becomes more expensive.
Stocks are falling. You know that. We’re going into a 3 day weekend. If you are very uncomfortable at the moment the feeling will most likely get worse between now and Tuesday.
I don’t believe in worst case scenarios. The sun will explode someday but it’s a lousy trade. That said, I do believe in market panic. I understand the animal spirits. I respect the power of the collective mood. There is nothing on earth that will dislocate a market quite like major currency problems. The basic assumption in any financial model is that valuation is based on a stable underlying currency. In the absence of said stability the numbers are gibberish.
There is no fundamental case to be made because who the hell knows what the Chinese are going to do if/when the Shanghai Comp burns like a wooden shed on Monday. Would a Chinese crash cause a recession here? I don’t know but the closer the $SSEC gets to zero the less I like our chances. Most stocks are worth more than zero but true value is not calculable. If you have no idea what a company will earn you can’t even create a PE ratio.
Under such conditions, doing nothing makes a ton of sense.
If the S&P500 drops to 1788 today we will have a genuine US Circuit Breaker. Presumably the Chinese would find this hysterical but, trust me, it won’t be funny here.
The last time the US markets triggered trading circuit breakers was 1998. The cause was “Impossible” currency fluctuations exacerbating the losing positions of a hyper-levered hedge fund called Long Term Capital Management. Most of you know the story. For those who don’t here’s a relatively lively academic overview.
On the topic of emotion being timeless, I’ve been reading up on the Panic of 1857 today. The trigger then was the end of artificially easy lending to fund the buildout of the the American rail infrastructure. Thank God nothing could happen like that today…
As I’ve said before, we’ve always known intervention doesn’t work. Governments simply can’t help themselves.
Why would I link you to these things when the stock market is obviously crashing? Because 20yrs of experience tells me the best way to burn off your fight or flight energy is to study, rather than trade. Analogies are not a gameplan. This time is ALWAYS different in critical ways. But humans never change.
Your trading opportunity will come from other people panicking. Your job is to be the smart money. Pick away at your favorite longs. Slowly. And do some reading. The crisis will still be here when you get back.
Stocks are down hard this morning because that’s how bear markets work.
For those of you who started trading after 2009, welcome to hell. You’ll find the heat a bit… stifling at first. I’m not going to lie, most of you are really going to hate the next few weeks. But, if I do my job and we all try to learn as we go along there’s no reason anyone needs to get wiped out like some house-flipping day-trader.
Stocks are set to erase all of Thursday’s gains right at the open. Blame China. Blame the GOP debate. Blame nothing at all. Price is reality. Here’s where we closed last night:
Here’s where we’re set to open this morning:
Digging deeper into the madness it looks like all the popular stocks (Either heavily-owned or those few with gains YTD) are down across the board:
Today is a day when technicals are both very basic and important. Watch Wednesday’s lows. If we take them out every single person who “bought the dip” over the last two days will be underwater. Disciplined traders take profits before winners turn into losers. Newbies tend to wait until they’re down before conceding defeat. Either way, there will be sellers. This isn’t chartist jargon speak. It’s no more complicated than training a dog with a shock collar. When something hurts sentient beings seek to stop the hurt.
I can tell you from personal experience getting suckered into a headfake rally hurts. A lot. That means selling. The Trillion Dollar Question is this: Will there be buyers?
You don’t need a lot of new material this morning. All the charts from yesterday still apply (since, you know, Thursday basically never happened at this point). I covered the emotions and basic strategy in my morning write-up and the closing video.
Here’s one chart. It’s the S&P500 over the last two years:
Counting from October 2014’s Ebola Lows (we hit 1820 intraday but closed in the mid-1800s) a reversal on the S&P500 anywhere between 1865 and 1850 would constitute a quadruple bottom.
Traders don’t believe in triple bottoms so you can imagine the suspicion with which they view the prospects of a knee-jerk bounce off ancient support. This is especially true in light of the freshness of yesterday’s pain.
Futures aren’t everything, as this week as proven. We could bounce but Friday’s are a matter of time. If we’re down hard at noon NYC time (with its fancy “NY Time Values”) there’s a decent chance today ends in tears.
Very few good decisions are made under pressure. Your instincts will probably betray you. Be afraid but not scared. Don’t make any trades without thinking about the risk-reward first.
For those of you who’ve been understandably avoiding your portfolio, the crash is here. At least it for some stocks it is (RIP: GoPro).
As I type futures are higher but yesterday started strong and ended in tears. Bear markets, and we are in a bear market, don’t so much have “trends” as thrashing convulsions. Deal with these things as one would an enormous living fish in the bottom of a canoe. It’s caught you as much as you’ve caught it. Caution is advised.
Here are some charts from earlier this year, updated to represent the ongoing nightmare. Back later. Try not to rock the boat…
S&P500: Support at 1860 is too obvious… Headed for 1,700?
1708 is an official Bear Market. If you wait for someone on TV to tell you when a bear market has started you’re going to end up in the Bear’s stomach. I’m telling you it’s a Bear. I’m as qualified as anyone.
Amazon: Filling gaps, as it does…
“Peak Amazon” was pretty good, as graph titles go. Shares are off 16%. History suggests about $525 is a decent spot to start building positions.
Apple: Honk if you’ve lowered your Q4 iPhone estimates!
Rough Day for Facebook
Twitter is like GoPro without the cool cameras… (Yes, I’m still long)
We’ve got all kinds of exciting things planned but at the moment we have more pressing matters.
The S&P500 is down about 1.5% after everything that could go wrong did over the weekend. In the unlikely event the pace of this sell-off continues throughout the year the S&P will finish 2016 down more than 97% at around 50. For the record, I am a buyer in size anywhere under 100.
If your 2016 investing plan hinged on Peace in the Middle East and unfettered Chinese capitalism you should probably sell. For every hour the Chinese have spent as capitalists they’ve got 100 days of experience being tyrants. Experience matters because it informs decision making under stress. When the Shanghai Comp fell 7% overnight the Chinese had a choice. They could let the free hand of capitalism find a price level for the $SSEC or go with their gut slam the market shut and execute some bears in public.
Obviously the Chinese went with the latter. It won’t work because government manipulation never works. (Longer form musings on the topic here: Brief History of Manipulation)
For now just know the Shanghai Comp is a disaster but still slightly better than where it was last summer:
As I said, we’ll get to more formal introductions over the next few weeks. Right now we have opportunity in front of us but only if you have a plan better than “Pretend I’m a long-term investor then puke up all my stocks at noon”.
The chances are very low you’re an expect on both China and the Middle East. Don’t trade off what you don’t know. Stick to your stocks. Go through your book. Look at levels.
Here’s a non-comprehensive list of stocks I’m watching into the new year. It’s a shopping list with the prices I’m willing to start putting money to work.
I don’t give advice. I tell you in real time what I’m doing with my real money. In 20 years I’ve never made money selling an open this ugly. I’m looking to buy where noted below. More later…