Do Share Buybacks matter?

Some interesting conclusions by the most bearish broker in town regarding share buyback. It is good to refer back to this report whenever there is a need to refresh our minds about common thoughts of share buybacks by companies and its impact on the underlying conpany's share price.

TheEdge: Analysts frequently argue that share buybacks provide a form of share price support and serve as a leading indicator of value as company share buyback activity is interpreted as ‘insider’ buying and as signs of management’s belief that the stock is undervalued. In this report, we examine the veracity of this thesis within the Malaysian context for the stocks under our coverage. About 36% of the stocks, by market capitalisation, under CLSA Malaysia’s stock universe have a share buyback programme in place. In attempting to answer this question, we examine in detail the individual corporate buyback activity over a one-year period from July 1, 2007 and also on two six-monthly periods, 2H07 and 1H08, as these correspond to different market cycles — in 2H07 the market was in an upward trend while in 1H08 it reversed sharply downwards. We then compare these results against its relative share price performance vs the KLCI.

Bull market buybacks (2H07)

In 2H07, companies collectively bought back 0.7% of outstanding shares. Ann Joo, Resorts and Top Glove bought back the most shares in the upcycle in 2H07, between 1.4%-2.8% of shares outstanding. However, the companies with the best six-month relative performance were those with zero buyback activity — Parkson, IOI and Sunway.

Bear market buybacks (1H08)

In 1H08, as markets fell, companies have been twice as active buying back shares, accumulating 1.2% of share outstanding versus 0.7% in 2H07. The most aggressive buyers were Sunway, IOI and YTL Power which did little in 2H07. But the best performers in the market, Ann Joo, Public and Berjaya Sports Toto, were again not those which were most active. In fact, Sunway was among the worst performing companies in 1H08, despite strong buyback momentum.

And the winners and the losers are…

Aggregating the results for the past 12 months and comparing share price performance with companies’ average purchase price yields some interesting results. Of the 13 companies under CLSA coverage, only Public Bank is currently in the money, while all other companies bought back shares at average prices above current share prices. The worst performing in terms of percentage losses are Sunway Holdings, Top Glove and Resorts (with current share price over 30% down from its average buyback purchase price). Among the big caps, the most active buyback companies are YTL Power, Resorts and IOI Corp, which have bought back between between 2.5%-3% of outstanding shares.

The conclusion is clear: share buybacks cannot be used with great reliability as an indicator for short-term performance. We estimate only a modest 0.4x correlation between relative outperformance versus KLCI against the percentage of shares bought back over the past year.

As a form of capital management, companies have three options to choose from in dealing with its treasury shares: a) Cancel the shares, b) Share distribution back to shareholders as dividend-in-specie and c) Sell/place shares at a higher price. As buybacks are a relatively new form of capital management in Malaysia (corporate Malaysia has only started actively buying back shares in the past two years), not many companies have a track record of visibility with how it treats treasury shares. We believe that the most value-enhancing action is to cancel shares, thereby boosting EPS or returning stock as dividend-in-specie (as a form of tax-free dividend). However, many corporates have not made decisions on what it will do with its treasury shares. Of the 13 companies under coverage, many have also chosen or are indicating intentions to sell shares at higher prices when prices rebound. It is unclear how this benefits minority shareholders directly, as cash accrues back to the company and any benefits remain one step removed from minorities. Only Bumi-Commerce cancels shares on a regular basis, while YTL Power distributes its treasury shares to shareholders. In the current bear scenario where the average cost of buyback is above current share prices, companies have even fewer options available to maximise value — 1) distributing shares could cause further sell down as minorities perceive these to be ‘free’ shares without capital outlay; 2) Placing shares below cost is a value-destroying move, leaving share cancellation as the only viable option, one that seems to meet with resistance when we speak to companies in Malaysia.

We believe that the lack of visibility in treasury shares treatment by companies is a plausible reason why share buybacks have not had a greater positive impact on share prices, unlike more developed markets such as the US and Europe. For now, share buybacks appear to be a very long-term capital management potential story for Malaysian companies.

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