As an investor, you’re supposed to adore buybacks. They return capital to shareholders. They’re a better use of cash than letting it moulder under the some corporate mattress. They betoken executive confidence. They make stocks go up. Usually.
Buyback love is particularly strong amongst hedge fund managers. Either out of material interest or some shared genetic trait, hedgies tend to be the most rabid fans of share repurchases. Activist plays from the likes of Carl Icahn or David Tepper almost invariably involve a demand that victims cannibalize their own stock. At any impasse, the speculator’s first answer is buybacks.
Not so with Arne Alsin. “Everyone’s been programmed now for a generation to believe in buybacks,” Alsin says. “The problem is the correlation isn’t working now, and it won’t work in the long term. It’s short-term thinking and it can’t continue.”
Alsin isn’t coming at buybacks from the ideological bent of, say, Elizabeth Warren. Nor is he repeating the tepid admonishments of Larry Fink. Alsin’s perspective is that of a guy trying to make an honest buck. He runs an investment firm. It’s called Worm Capital (explanation: “We’re gonna dig a lot”). With $105 million under management, the La Jolla, California fund has pulled down annualized returns of 27 percent since inception and 42 percent in the past year. Alsin has a simple rule of thumb: “We’re not long companies that do buybacks.”
To drive the point home, Alsin recently published a 91-page report outlining his theory. “Investors are being harmed” by “wildly excessive” repurchases, he writes. Buybacks are a “shell game” motivated by executives looking to boost earnings metrics and score huge bonuses. “Since 2010, over $3 trillion of shareholder cash has been withdrawn from corporate accounts and sent to the stock market for buybacks, generating zero tangible benefit for shareholders,” Alsin writes.
Hedgies reading this can go ahead and groan. But agree or disagree, Alsin has a coherent theory. When companies spend cash or issue debt to buy their own stock, he writes “what you get is the rough equivalent of a long-term call option on the stock.” He continues:
Unlike a dividend in which you get cash, you get no immediate tangible benefit from a buyback. It’s a future benefit. If the business does well, you’re apt to make a higher return, and if the business does not grow, much of the cash spent on buybacks is likely to be unrecoverable.
The retort here would be that shareholders do receive a benefit: increased ownership thanks to fewer shares outstanding. But that’s increased ownership in a poorer company. There is a tax benefit in using buybacks to alter a company’s capital structure, but it’s not huge. “The one thing that grates on me is that corporations say they’re returning cash or capital to shareholders,” Alsin says. “It’s a misrepresentation.”
To demonstrate the idea, Alsin does a thought experiment: What if all those buybacks everyone’s been doing were instead special dividends? Analyzing the 30 component stocks of the Dow Jones Industrial Average over the (admittedly short) period of 2014-2016, Alsin found that 11 percent of shareholder property, as he calls, it was “withdrawn from the corporation and sent to stock market.” If those buybacks would have been plowed instead into dividends, the Dow would have hit a dividend yield of 8 percent.
What does that matter for investors? Contra certain theories, Alsin sees a stark difference in shareholder payout mechanisms. In the case of a dividend, shareholders take on a higher risk (a more levered company) for which they receive direct compensation (cash). With buybacks, shareholders wave goodbye to a risk-free asset (cash) and receive increased ownership – an “asset” with higher risk that has to be sold at the right time to be realized. If that time ever comes.
Of course, plenty of stocks have donegreat with buybacks. But failures abound. Alsin presents a rogues gallery of buyback malefactors: Sears guzzled down nearly $6 billion of its shares between 2005 and 2010, roughly six times the company’s current market cap. Bed Bath and Beyond bought back about the same amount in the past five years, during which time its stock price has halved. The $80 billion Hewlett Packard has blown on its own shares since 2000 exceeds the market cap of the two companies that now make up HP.
But there’s no greater buyback villain in Alsin’s mind than IBM, which has bought back more than $110 billion over since 2000, nearly 80 percent of its current market cap. That’s a matter of some annoyance to Alsin, who happens to be short Big Blue. “It’s really hard to overcome,” Alsin says. His anti-buyback crusade, he admits, is “born of frustration” over IBM’s relentless buyback machine.
The perceptive reader will notice that the companies above have something in common: They’re all getting smoked by Amazon. That company makes up the largest share of Worm’s portfolio and, incidentally, hasn’t done any buybacks since 2012. “I gotta blame everything good and bad that happens to Worm on Amazon,” Alsin admits. He also owns Tesla. “It just so happens that all the most innovative companies don’t have cash lying around to buy back stock.”
Of course, these companies might do loony things with investor cash – like, say, buy their cousin’s company or make their product line spell out S-E-X. But Alsin prefers that to buybacks. His conditions for an acceptable buyback are when a company is both growing organically and not in an actively disrupted industry. In Alsin’s reckoning, just three Dow companies fit those criteria.
Given the above, the obvious question is why, if buybacks were so bad, shareholders have sat back and allowed themselves to be so viciously abused by corporate boards for so long. Alsin says short-termism plays a part. “Investors say, ‘Man, this is helping my stock,’ so they just can’t get motivated to challenge it like they should,” Alsin says. “It’s short-term thinking and it can’t continue.”
That’s the rub. If Alsin is right, we should know sooner or later. If scads of major companies are wasting cash and passing over organic growth opportunities in a self-destructive debt binge that serves only to juice executive bonuses, eventually there should be some sort of reckoning – at least one well beyond a few department store chains. It’s already clear that companies with the largest repurchase records trail the rest. Give it another 10 years and maybe we can finally all stop having to have an opinion about buybacks at all.