When companies announce share buyback programs, investors and analysts often applaud. But all buybacks aren’t created equal, and many actually destroy shareholder value rather than create it.
Buybacks are a sign that a company believes that investing in its own stock is the best possible use of capital, and investors like to see this kind of confidence. But more often than not companies overpay for their own shares, sometimes taking out debt to do so, while better uses of the capital exists. And the proliferation of stock-based compensation clouds the benefits of buyback programs and reduces their effectiveness. Let’s look at three companies that have genuinely terrible buyback programs.
No benefit at all
When a company is deciding how to allocate capital, the first choice should always be to invest back in the business. Only when this isn’t feasible should companies turn to dividend or share buybacks as an alternative. But the price has to be right, and for fast growing companies this often is not the case.
Consider Chipotle Mexican Grill, Inc. (NYSE:CMG), for example. Chipotle Mexican Grill, Inc. (NYSE:CMG) is a fast growing company, with revenue growing by 20% and net income increasing by 29% in 2012. The company is building its store base rapidly, and capital expenditures greatly outpace depreciation. Does a buyback make sense for this company?
Chipotle Mexican Grill, Inc. (NYSE:CMG) has been buying back shares in modest quantities for years, with 2012 seeing $217 million worth of buybacks for the $11 billion market cap company. The company generated $223 million in free cash flow in 2012, so basically all excess cash is going to the buyback program.
Like many companies, Chipotle Mexican Grill, Inc. (NYSE:CMG) awards executives with stock-based compensation. In 2012 the value of this compensation totaled $64 million. What this means is that part of the buyback money actually goes to negating the dilution caused by the compensation. From the end of 2010 to the end of 2012 the share count actually increased even though the company spent $280 million on share buybacks. These buybacks, then, are a real cost that are required to prevent even further dilution of the share base. So even though the total free cash flow in 2011 and 2012 combined was $483 million, the true profits were just $203 million over that time, or about $100 million per year. The stock trades at about 100 times this figure.
Shareholders are receiving no benefit at all from Chipotle Mexican Grill, Inc. (NYSE:CMG)’s share buyback program. In fact, the program is destroying shareholder value. The company is a whole lot less profitable than the commonly used figures suggest, and the stock should be avoided.
Are you Sirius?
Sirius XM Radio Inc (NASDAQ:SIRI), the satellite radio company, has a different problem that Chipotle Mexican Grill, Inc. (NYSE:CMG). In December Sirius XM Radio Inc (NASDAQ:SIRI) announced a $2 billion buyback program to the glee of many Sirius XM Radio Inc (NASDAQ:SIRI) investors. But does it make any sense? Will it actually be good for shareholders? No, it doesn’t and it won’t.