When CEOs Run Out of Good Ideas
In a business that thrives on fads, the hottest mantra among media investors is “return capital to shareholders.” At nearly every investor presentation or earnings conference call, media CEOs and CFOs are peppered by analysts and money managers with questions about the company's plans to boost its share price by buying back its own stock or starting to pay dividends.
Media giants have responded by allocating billions of dollars to placate them. Comcast Chairman Brian Roberts is spending $2 billion on buybacks; Clear Channel is completing its third $1 billion buyback in just the past year; and Time Warner just initialized its first-ever dividend, committing to pay out nearly $1 billion annually. EchoStar has spent nearly $1 billion buying back its own stock and another $455 million for a one-time dividend to shareholders.
And investors want more. DirecTV is bombarded with queries about buybacks, as are other big media companies. But, for all the billions spent in the past year or so, it is hard to point to any dramatic benefit. The companies with the biggest buyback programs haven't seen their stock prices rise; in fact, they've sunk. Investors were initially wowed, but enthusiasm has evaporated.
Do the math
There is lots of arithmetic supporting the view that shrinking a company's outstanding shares should increase value. And any investor who trusts management should love the idea that CEOs see their own shares as cheap. Companies talking about buybacks have their own mantra; they see no better place to invest capital than in their own stock. (Of course, any investor who doesn't trust management should have sold long ago.)
But when I see a big buyback, I tend to look at the downside. Media CEOs may be showing faith in their stocks, but they're often also signaling problems in their core operations. They don't see any smart acquisitions—ones that both fit well and are priced to generate a reasonable return on investment targets—beyond their companies.
Worse, companies buying back shares don't see enough expansion opportunities inside their companies to invest their cash in. The more you trust management, the bleaker that signal should be.
The call for buybacks and dividends is a backlash to the deal frenzy of the late 1990s. The same investors and analysts who for years cheered mega media deals watched too many of them fizzle. They have now changed their tune, imploring CEOs to cough up the money.
Research by Bank of America media analyst Doug Shapiro shows how badly some sizeable media mergers have misfired, including Viacom/CBS, Comcast/AT&T Broadband and AOL/Time Warner. (I disagree on one: AOL/ Time Warner was one of the most brilliant takeovers ever—for AOL shareholders. Without buying Time Warner, AOL's book-cooking likely would have bankrupted the company and wiped its shareholders out. Instead, they wound up with half of Time Warner.)
Increase Demand, Shrink Supply
So why buy back stock? In the short run, it should firm up trading prices by increasing demand at the same time it shrinks the supply of shares. In the long run, it artificially boosts measures like earnings per share by shrinking the number of outstanding shares.
And if a company's stock price ultimately ises at a greater rate than their cost of capital, the company succeeds in the most important measure of all: return on investment.
Dividends are different, promising shareholders a little bit of income—up to 2% of the current price of their shares—and making a stock a little bit like a bond.
Why did Time Warner CEO Richard Parsons decide to spend on dividends rather than a buyback?
First, he thinks it demonstrates a longer-term commitment to investors. Second, he thinks it will enforce more discipline on his executives to meet their goals, because dividends are an obligation managers must meet each quarter.
Neither option has been very popular for media in the past. Many media CEOs preferred to dedicate their financial power to expanding existing operations or acquiring new ones. It is more fun—and it is in the CEO DNA. Their first inclination is to grow; growth is generally the best sign of a healthy company and something Wall Street often rewards well.
But does spending billions of dollars on stock buybacks work? Two academics who have studied buybacks, Harvard Business School finance professor Samuel Hayes and Clemson University's Daryl Guffey, say they're no panacea. “Usually there's a short-term effect in the stock price,” says Guffey. But “three to five years down the road, usually the stock price hasn't fared that well.”
Look at media's most active buyers. Since the beginning of the year, Viacom's stock is down 7.3%, despite the buybacks and the breakup plan. Comcast is down 4.6%, Clear Channel is down 12% and EchoStar is down 9.9%.
Hayes discounts such recent declines. “That's not even short-term,” says Hayes. He contends that, if healthy companies repurchase their shares smartly, “in the long term, it has a tangible effect.”
But Viacom is a good example of why buybacks aren't necessarily a good idea. Last July, Chairman Sumner Redstone gave investors what they wanted, declaring that Viacom would budget a massive $8 billion buyback of its own stock. That would shrink the company's equity base by a huge 15% and jack up Viacom's stock price, right?
Wrong. Viacom quickly gobbled up millions of its own shares, with little apparent effect. By March—after having spent $3.4 billion—a frustrated Redstone made an even more drastic move, declaring that he wanted to split Viacom in two; he hopes investors will be more responsive to separating the high-growth MTV Networks from Viacom's slowly growing broadcast operations.
That leaves CEOs in quite a dilemma. Where do they spend their cash? All I know is that a big reason you buy stocks is management should know how to invest the money.
A CEO whose best option is to buyback the company's shares isn't any smarter an investor than you are. Perhaps that means it is time to move on to another stock.
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