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Example of engineering short-term increase in EPS at expense of access to capital needed for business viability


For previous Forum attention to the issues addressed in the commentary below about the use of corporate capital to repurchase stock, see the "Stock Buyback Policy" reference section of a Forum project that had addressed a company-specific example and the online user-input "Buyback Analysis" calculator developed in a Forum workshop.


Source: Financial Times, August 4, 2019 commentary



Opinion Inside Business

Boeing and the siren call of share buybacks

Fair-weather strategy carries risk for investors



Investors are waiting to see how long the 737 Max will be grounded, what the costs will be, and whether contracted sales will hold up © AFP

Jonathan Ford  AUGUST 4, 2019


One of the oddities of the modern US stock market is its strong predilection for share buybacks. Rather than finding profitable outlets for their cash holdings by investing internally, corporations have taken to shrugging their shoulders and simply handing the stuff back en masse.

The idea of shrinking the number of shares outstanding has acquired its own momentum, and buybacks have become an important driver of stock market performance. In recent years members of the S&P 500 have increased their spending on their own stock, last year retiring 4 per cent of the index’s capitalisation. That is equivalent to $800bn.

Those buying back are not only mature companies, whose need for investment might be lower. They include growth stocks such as tech companies and those with big investment needs including pharmaceuticals and defence. Indeed, one of the heftier spenders of recent years has been aerospace giant Boeing.

The company might seem an odd candidate for a big buyback programme. Its civil aviation business involves huge multiyear projects in which billions of dollars of capital are put at risk. The programme for the 787 Dreamliner, for instance, lasted eight years and cost $32bn.

Yet Boeing has found the financial space to splurge on its own stock. Between 2013 and the end of the first quarter of this year, it retired a net 200m shares, handing back $43bn to holders. The number outstanding came down by 25 per cent.

One reason it could was because of savings on the company’s latest aircraft programme, the now notorious 737 Max, grounded after two recent crashes killed 346 people. Instead of building a wholly new aircraft, Boeing simply bolted new fuel-efficient engines on to a tweaked existing airframe. That significantly reduced the airframe development costs of the project, according to company insiders. Boeing was able to redirect some of those “savings” to repurchase stock instead.

It illustrates a choice that many chief executives have willingly made: to prioritise buybacks over investment. In this, they have received little but encouragement from their financial backers. Share repurchases seem a good bet to investors who are highly focused on short-term share price performance compared with the uncertain (and longer-term) gains from new product development.

Buybacks are, after all, the very purest form of financial engineering. Unlike special dividends, they don’t simply gear the balance sheet, they supply a further twist by reducing the number of shares in issue. The result is to manipulate upwards the earnings per share number — sometimes quite dramatically. In Boeing’s case its effect was to push EPS last year up 20-25 per cent against what it would have been without the repurchases since 2013.

Who benefits from this optical leverage? Not necessarily the shareholders. Buybacks tend to happen when share prices are rising anyway, exposing them to the risk of the company destroying economic value by repurchasing overpriced equity. The biggest winners are managers, especially those whose remuneration is tied to stock market measures such as EPS growth. Take Boeing’s chief executive Dennis Muilenburg. Since becoming the boss in 2015 his pay has doubled. Last year he took home a thumping $30m in compensation and gains from exercising options.

The problem with buyback gains is that they are based on nothing more than making equity prices more volatile. So while profits and share prices are rising, the lucky executive cashes in on the favourable optics, pocketing bonuses that won’t be subject to subsequent disgorgement.

But buybacks are a fair-weather strategy. So if events later sour, investors not only give up all the optical gains: volatility occurs on the downside as well, thus magnifying the share price decline. Falling share prices can in turn have knock-on effects, such as clobbering credit ratings.

Boeing embarked on its buyback splurge against a backdrop of rapidly growing sales and profits due to the sales success of the 737 Max — on course before the crashes to be one of the best-selling airliners of all time. Now, however, the outlook has become extremely murky. Suggestions that Boeing indulged in shortcuts to speed the plane’s path to market may even imperil consumer trust.

The shares have fallen by nearly a quarter since the March crash, leading to the cancellation of a $20bn buyback programme announced in December. Investors are waiting to see how long the Max will be grounded, what the costs will be, and whether contracted sales will hold up.

Boeing faces a period of magnified instability. Investors might usefully ask themselves how much their focus on the short run has contributed to this predicament. Perhaps it might have been better had bosses indulged in rather less financial engineering and rather more of the real kind.


Copyright The Financial Times Limited 2019.



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