Share Repurchases: We Need Change
I was flipping through Intel’s (INTC) 2014 annual report the other day when I came across an interesting comment from the company’s chairman of the board, Andy Bryant (link):
“Intel repurchased $ 10.8 billion worth of Intel stock in 2014, five times the level of 2013.”
To put that number into content, Intel generated $ 20.4 billion in cash flow from operations in 2014; after accounting for $ 10.1 billion in capital expenditures, we’re left with free cash flow of $ 10.3 billion. In other words, Intel spent more than 100% of free cash flow repurchasing its own shares in 2014. By comparison, Intel spent a relatively small percentage of FCF on repurchases in 2013 (roughly 21%).
The reason why Bryant’s statement stood out to me was because I had a rough idea of what the stock price has looked like over that period; let’s start with 2013 (these charts are pretty small, so you might want to pull up the price history on your own):
As we can see, the stock traded between $ 20 and $ 24 per share for the majority of the year (~90%); from what I see, INTC did not cross $ 25 per share until the last two weeks of the year.
Now let’s compare that to the chart for calendar year 2014 (aligned with Intel’s fiscal year):
As we can see, the stock traded between $ 24 and $ 37 per share for the vast majority of the year (~95%). That’s a wide range, so let’s dig deeper: as we can also see from the chart, INTC only crossed $ 30 at the tail end of the first six months of the year (halfway through June) – and spent most of the period trading between $ 25 and $ 27 per share.
By comparison, Intel never traded below $ 31 in the back half of the year; the stock traded at an average price of $ 34 or $ 35 per share in the last six months of 2014. For the sake of simplicity, let’s call it 30% higher on average than in the first six months of 2014 (~$ 34 versus ~$ 26).
The progression through 2014 is pretty clear: the stock price, on average, moved higher as the year went on; when it was all said and done, Intel’s stock was up by more than 40% for 2014. For some perspective, free cash flow per share increased by roughly 5% for the year. You would have a tough time arguing intrinsic value increased anywhere near the rate of the stock price.
So with that, we can confidently state a few things: first, we hope management was more aggressive on repurchases in 2013 than they were in 2014; the stock price was clearly more attractive relative to intrinsic value in 2013 than it was by year end 2014. Unfortunately, as highlighted by Bryant, that was not the case: Intel spent five times as much money on repurchases in 2014 – a number that is not sustainable after accounting for CapEx, normalized M&A and a growing dividend. On this first test, management does not receive a passing score.
Next, we know that share repurchases in the first half of 2014 were much more attractive for the ongoing owners of the business than those completed in the back half of the year. When we look by quarter, we can see that the outcome on this measure also suggests an unimpressive result:
When the stock was below $ 25 per share, management had very little interest in buying back shares. Six to nine months later, with the stock trading 40% higher than where it had been in the first quarter, they were buying hand over fist.
For the year, they bought back 332.4 million shares at an average cost of $ 32.50 per share; that’s roughly 11% higher than the daily average close for the stock in calendar 2014 (according to Yahoo Finance data). As an investor, I would not be satisfied with this result (this is a short period of time; with that said, I think we can confidently conclude this data is not encouraging).
Intel is far from an outlier; from what I’ve seen, this is the status quo for publicly traded companies. From what I can tell, most managers and boards only view share repurchases on the most elementary level: “more = better”. Anybody with a cursory understanding of business and market cycles can see why companies consistently buy back shares in size when the stock price is high, only to lose all interest when prices fall 30%, 40% or more.
As I’ve noted in the past, this cannot be glossed over: as capital returns have shifted to share repurchases, the impact of questionable buyback timing has been amplified. In the case of Intel, repurchase spending has consumed roughly 63% of Intel’s cumulative free cash flow in the past three years ($ 17.7 billion of $ 28.2 billion). This has a material impact on intrinsic value.
In 2015, Intel’s stock price hasn’t held in the mid-to high $ 30s: it has fallen roughly 20% year to date (~$ 29 per share) and was down by more than 25% at its low point for the year.
But despite a more attractive stock price, management has lost their appetite for share repurchases: the company spent less than $ 1.5 billion on repurchases in the first six months of the year, or roughly one-fifth of what was spent in the final six months of fiscal 2014. If the goal is to repurchase shares at the lowest average cost, they clearly are not succeeding.
In my opinion, the traditional approach to share repurchases in corporate America is based on a fundamentally flawed calculation; targeting a certain dividend payout ratio while using the remaining FCF to repurchase shares assures that, on average, companies will buy back mountains of stock when times are good (and valuations are expensive), only to sit on their hands and do nothing when the business hits hard times (and shares are cheap).
During a recent investor conference, IBM’s (IBM) CFO noted that his primary role is allocating capital. It’s not clear that other CFO’s agree; I noted back in 2014 that Coca-Cola’s (KO) CFO (at the time) believed share repurchases were “value neutral” and did not “grow value” for the long-term investor (source). I can think of a large shareholder in Omaha who disagrees.
That’s amazing when you think about it: companies are spending billions on repurchases – in many cases more than they spend on CapEx and M&A combined; at the same time, they’ve failed (on average) to do as well as they could by simply buying a set dollar amount of shares each month. They apparently don’t know or care about the impact this has on intrinsic value.
Companies that work tirelessly to save a few million dollars in their operations deploy billions without considering if they’re doing so intelligently (on average, they’re not); this must change.
Until bad ideas are questioned by influential / large shareholders, managers and boards will continue with the status quo; I hope that this happens sooner rather than later.
About the author:
I’m a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves (potentially over a period of years). As this would suggest, I run a fairly concentrated portfolio by most standards, usually with the majority of the value in a handful of names; from the perspective of a businessman, I believe this is more than sufficient diversification.
I hope to own a collection of great businesses; to ever sell one, I demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don’t have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question – which if I’ve done my job properly, should be very attractive over many years.