For a company that supposedly has more cash than it knows what to do with Apple sure raises a lot of debt.

This morning Apple filed with the SEC for a debt offering of an amount TBD. Details are sketchy…

… 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.

 

 

The Problem

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.

 

See:

Apple’s Buyback: Still iDiotic

Buyback Primer: Autonation, IBM, Apple, Chipotle and More….

Big Blues: IBM’s $70b Boondoggle

 

 

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Buyback-Lash(TM) is picking up steam as investors sell-off shares of companies with monster buyback programs. Apple, IBM, Chipotle, Gilead… the list is growing.

The story is also picking up steam. Perhaps inspired by the Weekend Buyback Primer I created with links to pieces on AutoNation, Apple, WholeFoods Markets, Macy’s and IBM) Fortune went through Apple’s hypothetical P&L on repurchased shares yesterday:

 

It’s a decent read but misses the main points. Allow me to elaborate:

Repurchased Shares Go to $0 Immediately

I went over exactly why in the nuanced piece “Wall Street Street Screwed You Again! Buyback Mailbag“. It’s a nice exercise to point out that Apple is down 21% on buybacks but it misses the point.

If shares move higher after a repurchase the company has no direct benefit. Apple doesn’t trade its shares. If AAPL were trading at $200 the company itself wouldn’t be able to flip stock for a profit. Unlike literally every other potential investor corporations can’t just flip shares in the open market. The stock is instead retired to reduce share count.

In part this offsets dilution from stock option programs. That means buybacks are a good pay to hide pay and help push EPS higher all things being equal. Most executive pay packages are based at least in part on earnings per share. Buying back stock is easier than coming up with new business ideas and can lead directly to an executive team getting paid more, regardless of what the stock itself does.

Buybacks Don’t Work

On their call last night Gilead announced it had spent an insane $10 billion repurchasing shares at an average cost of $95. As a result EPS in the fourth grew faster than net income! Ya! Everyone got a bigger chunk of the earnings pie! Gilead added another $12 billion to its $15 billion repurchase program last night. $27 billion and the company is openly accelerating buybacks right this second.

The problem isn’t that Gilead is down $10 on its investment. Gilead is down $10b but that’s not even the problem. The real issues are a) shares are going lower anyway b) that money might come in handy some day c) Gilead is competing for stock with its own investors even though Gilead has no real use for the stock.

That’s not returning cash to shareholders. It’s screwing them in the short term so your monster options package is less visible.

Yes, Gilead generates a ton of cash. So did IBM at one point. $75b in buybacks later IBM, a company once so powerful it was considered a monopoly, has missed every trend of the last decade. IBM shareholders are left with net profits of $0 since 2010.

 

Parade of Dunces

Financial media is like a game of telephone. Somehow has an insight then everyone passes it alone in some slightly different form. I’m not complaining or bragging about other folks picking up on this story without attribution. I expect that to happen. I just want to make sure they get it right. It’s important because investors should be insanely outraged right now and it’s not quite happening.

Among the inanity…

Chipotle spent 30 minutes detailing every margin-crushing hell that can befall a company on last night’s call. -36% comp sales, loyal customers abandoning them, promotions of unknown expense and higher costs in general. I was on the call. Shares held up fine right up until the CFO said this:

This was after the company guided to breakeven for Q1 and pulled guidance for the rest of the year because he openly has no idea how much the company will have to spend to buyback shares. How about settling the NoroVirus investigation before getting long CMG, guys? Because the stock really isn’t a buy as long as we’re synonymous with both bacterial and viral ways of contracting explosive diarrhea.

Comcast hiked buyback by $10 billion. Because the best way to fight cord cutting and ad drops is investing in your own stock.

Buybacks Need to Die Before Walmart Does

They never make sense. “Opportunistically buying back shares” is the 2016 version of Citi’s Chuck Prince blithely telling the New York Times that his bank was taking on more debt because “as long as the music is playing you’ve got to get up and dance“.

Citi still has risk to $0.

Walmart has $20b in repurchases in place. Target is buying its own stock. Amazon is not. Amazon is going into bookstores. Those are Trojan Horse distribution systems. Target and Walmart have a combined growth rate of 0%. Both chains get less than 5% of its sales from online. By Christmas Amazon will be killing them ecommerce and brick and mortar stores.

Walmart is spending under $1b developing its internet business this year. How much cash do you think there will be to return to shareholders in 10 years if Walmart doesn’t create a viable online presence?

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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.

My collected buyback screeds from the last month:

 

Wall Street Screwed You Again!

 

 

Still iDiotic: How’s the Buyback Going, Apple?

 

 

 

Macy’s is Dead (from Jan 7)

 

Big Blue Bloodbath (Jan 20)

 

How’s The Buyback Going, AutoNation?

My insanely awkward 2013 chat about buybacks with AutoNation CEO Mike Jackson.

 

Wholey F-d: WFM Shares Drop Below Buyback Bottom

Low rates make this a “perfect situation” to fund buybacks with cash.. said Whole Foods in November with the stock in the 30’s.

 

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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.

AR–

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.

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