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Chipotle Mexican Grill, Inc. (CMG), Sirius XM Radio Inc (SIRI): These Buybacks Are Terrible

Sirius XM Radio Inc (NASDAQ:SIRI) is funding this buyback through cash on hand, the free cash flow, and taking out more debt. At the end of the first quarter Sirius XM Radio Inc (NASDAQ:SIRI) had about $200 million in cash after spending $466 million on buybacks. The debt totaled $2.18 billion, on which Sirius XM Radio Inc (NASDAQ:SIRI) paid $265 million of interest in 2012. Free cash flow in 2012 was $700 million, but Sirius paid no taxes due to a huge tax benefit. Sirius will need to take out more debt to complete the buyback, which is a seriously terrible idea.

Sirius’s free cash flow per share is about $0.10. With a share price of about $3.50 the stock trades at 35 times the free cash flow, and that doesn’t even factor in the debt. The message that Sirius is sending with the buyback is that buying its shares at 35 times FCF is a better investment than reducing its debt. The effective interest rate on that debt in 2012 was just shy of 10%, so it seems like a far better use of its cash and cash flow would be to pay off the debt instead of taking out more to buyback shares. If the company used the next three years worth of free cash flow to eliminate the debt it would increase profits considerably. This seems a lot more shareholder-friendly to me.

If a company takes out debt to fund a buyback, the stock better be seriously underpriced. This is not the case with Sirius, making the massive $2 billion buyback program a terrible idea.

Layoffs and … buybacks?

A few days ago troubled game company Zynga Inc (NASDAQ:ZNGA) announced that it was laying off 18% of its workforce. With revenue shrinking after years of rapid growth the company needs to cut costs, and these layoffs do just that. This announcement comes 8 months after the company announced a $200 million buyback program amidst weak earnings and falling revenue.

So here’s a question: if the company is failing, with mass layoffs and consistent unprofitability, why in God’s name is money being spent on a buyback? What does that accomplish? The focus should be to make Zynga Inc (NASDAQ:ZNGA) a viable company, not to artificially boost the stock price. Zynga’s business model is failing, and its push into online gambling is far from showing any real results. What is the management thinking?

Who would have thought that a business model revolving around free-to-play games wouldn’t work? Oh yeah, everyone. The stock price may look cheap at around $2.80 per share, down from a post-IPO high of $14, but it’s not. The company is valued at $2.2 billion, roughly twice annual sales. The company is sitting on $1.2 billion in cash and little debt, but as losses continue the company will likely need this money.

Another problem is the absurd levels of stock-based compensation. In 2012 the company awarded $282 million in stock options, a full 22% of the revenue. This has caused the share count to explode, and it will continue to explode as long as this practice continues. And now, with the stock price so low, retaining employees with the promise of stock options will be less effective.

Zynga is in trouble, and the idea that the company should waste money on a buyback is ludicrous. Investors should have been outraged by the announcement, not elated. Zynga is one of the least shareholder-friendly companies in the market today.

The bottom line

Some buybacks are good, with companies using excess cash to buy their own shares at a reasonable price. But some buybacks, like the ones highlighted above, do more harm than good. I’d avoid all three companies, as they care far more about boosting the share price than anything else. That’s a recipe for disaster.

The article These Buybacks Are Terrible originally appeared on Fool.com.

Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill (NYSE:CMG). The Motley Fool owns shares of Chipotle Mexican Grill. Erin is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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