atans1

Buybacks: problematic in bear markets

In Accounting, Corporate governance on 03/03/2010 at 5:20 am

Based on filings with SGX in the last week of February, “the buybacks among listed firms surged last week, after very low activity for three straight weeks. A total of six companies posted 17 repurchases worth $2.1 million. The number of transactions was more than the seven repurchases from Feb 1 to 19. Among the stocks that recorded significant buybacks last week were KTL Global, HTL International, and InnoTek”, reports BT.

The theory is that a company buys back its shares when it thinks the market is undervaluing the shares.  But buying in a bear market can cause problems especially since bear markets can only be recognised in hindsight.

In a bear market, buybacks become a bad tool of creating shareholder value, and can cause management problems if they want to issue  new shares to fund an investment.

One Warren Buffett said a few months ago, ” What we know with certainty, however, is that Kraft stock, at its current price of $27, is a very expensive “currency” to be used in an acquisition. In 2007, in fact, Kraft spent $3.6 billion to repurchase shares at about $33 per share, presumably because the directors and management thought the shares to be worth more.

‘Does the board now believe those purchases were a mistake and that Kraft’s true value is only the current price of $27 per share – and that it is therefore fine to structure a major acquisition based upon that price? Would the directors use stock as merger currency if the price were, say, $20 per share? Surely the true business value of what is given is as important as the true business value of what is received when an acquisition is being evaluated. We hope all shareholders will use this yardstick in deciding how to vote.”

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  1. error in your article, it should be bull market in opening of 3rd paragraph

  2. [...] Warren Buffett if he had been a Pru shareholder would agree with them.  “You simply can’t exchange an undervalued stock for a fully-valued one without hurting your shareholders,” he recently said. And he had earlier criticised Kraft for placing out its shares at lower prices than it had earlier bot back shares, in order to finance the Cadbury takeover, illustrating the problem companies face when buying back in what in retrospect is a bear market. http://atans1.wordpress.com/2010/03/03/buybacks-problematic-in-bear-markets/ [...]

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