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Agreeing with Milen

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April 21, 2009 – Comments (5)

It's a strange feeling, but hey, I think he's right.

http://online.wsj.com/article/SB124027187331937083.html

Why Capital Structure Matters
Companies that repurchased stock two years ago are in a world of hurt.

By MICHAEL MILKEN

...
Issuing new equity can of course depress a stock's value in two ways: It increases the supply, thus lowering the price; and it "signals" that management thinks the stock price is high relative to its true value. Conversely, a company that repurchases some of its own stock signals an undervalued stock. Buying stock back, the theory goes, will reduce the supply and increase the price. Dozens of finance students have earned Ph.D.s by describing such signaling dynamics. But history has shown that both theories about lowering and raising stock prices are wrong with regard to deleveraging by companies that are seen as credit risks.

Two recent examples are Alcoa and Johnson Controls each of which saw its stock price increase sharply after a new equity issue last month. This has happened repeatedly over the past 40 years. When a company uses the proceeds from issuance of stock or an equity-linked security to deleverage by paying off debt, the perception of credit risk declines, and the stock price generally rises.
...

This is what I believe is the key issue. The "signal" has, for too long, been more important than business reality. Simply put, companies were buying stock in order to drive up their stock prices, not because it made the best sense as far as allocating capital.

Sj

5 Comments – Post Your Own

#1) On April 21, 2009 at 9:42 AM, TMFDeej (99.40) wrote:

I completely agree, Seth.  I have never been a huge fan of buybacks.  As a part owner in a company, I personally would rather be given the money in the form of a dividend and be given the option of buying shares or doing something else with it.  At that point, I could only blame myself if I reinvested dividends at too high a price (ALV cough).

Too often buybacks are nothing more than a way for companies to hide dilution from massive options grants or just a way for management to try to manipulate the stock price, not actually invest capital wisely. 

If the managers of a company that I own decide that they can't find any better use for their cash flow than buying back stock, give me the money that's rightfully mine.  Of course, tax issues come into play because one has to pay tax on dividends and distributions but I'll worry about that on my own.

Deej

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#2) On April 21, 2009 at 9:46 AM, TMFBent (99.82) wrote:

Or Milken, even...

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#3) On April 21, 2009 at 9:47 AM, TMFDeej (99.40) wrote:

BTW, this conversation is very similar to one that has been going on in the comments section of my latest blog post.  Here's a link if you're interested:

http://caps.fool.com/Blogs/ViewPost.aspx?bpid=183311&t=01001019292467236494

It's a great piece if I do say so myself ;).

Deej

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#4) On April 21, 2009 at 9:48 AM, TMFDeej (99.40) wrote:

You had me worried, I thought that you were agreeing with the former Detroit Lion's GM Matt Millen's decision to draft a wide receiver at the top of the first round for ten consecutive years.

Deej

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#5) On April 21, 2009 at 10:26 AM, TMFBent (99.82) wrote:

Well, I agree, in general, with any bad decision-making by the Detroit Lions that can benefit the Vike-lings.

Sj

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