Thanks for the research and concise presentation. As a novice in the bond market world, I wonder where can one obtain data on investment and high yield credit spreads?
Let's get the comments rolling with this one from a friend, who never posts anywhere but who is never shy with an opinion:
Who knows what the market will do but not sure he is right about this. When interest rates were 0%, you borrow to fund buybacks, because it is accretive. Apple prime example.
Now if you have to borrow at 5%-7%, and your PE is 20 or more, the buyback is not accretive to EPS. That would be dilutive.
So obviously, there is still borrowing going on, but that is probably to fund operations as opposed to fund buybacks.
Obviously there are still buybacks going on too, but they are being funded by the cash already borrowed previously (but not used up yet), or by cash from operations.
Anyway, my point is I wouldn’t draw too much linkage now between the debt markets and buybacks.
Then the other thing is you have to look at buybacks not just in gross $, but as a % of total market cap out there. Market cap and multiple on some of these companies is so high now, they are no longer reducing share count with their buybacks.
Then as you point out, they are announced, but always hard to know the rate at which they will happen.
My 2 cents, market could go up, could go down, but I do not think buybacks funded by the current debt market will be part of why.
Fil responds: don’t necessarily disagree that higher rates on the margin deter borrowing for buybacks, but the point I was trying to make is that the willingness of credit markets to lend to companies who might want to do buybacks is key. If the credit markets are shut, many companies won’t spend their cash on buybacks because they don’t want to be caught short for other purposes. So the whole buyback process shuts down completely. If credit markets are in good shape, maybe cos will borrow for buybacks or maybe they only use their cash, but the buyback desks will kick in if they have the mandate. In other words, “money is fungible”… but only as long as it is available.
A couple of other points: yes, if borrowing costs are too high relative to the valuation of the shares it may not make sense to carry out buybacks. But valuations are fluid: is the company only looking at today’s valuation? What if they expect fast growth? What if their capitalization is mostly equity and their equity cost of capital is very high because the market is skeptical of the company’s outlook/operations? Calculating equity cost of capital is hardly a science and many CFOs may well be inclined to bring down the WACC with some debt for buybacks.
As to the actual costs of borrowing, and this is important with respect to distinguishing between IG and HY companies, the borrowing rate mentioned by your friend is way too high even at “currently high” base rates (I used quotes because I am also old enough to remember 15% treasury coupons). When cos borrow expressly for buybacks or “general corporate purposes” (which often includes buybacks) they use short dated debt, usually no more than 3 years. If you want to use CAT as a proxy, which is “A” rated (only 2 steps above junk) but has a pretty hefty amount of debt and patchy FCF, in August it sold 3yr bonds at 4.4%. Or take Oracle, a BBB (so technically junk) which also has a lots of debt but also much steadier FCF, its 3yr bonds trade at 4.1% right now.
Lastly, yes companies can announce buybacks and not go through with them, but unless something drastic happens on a macro level, most generally do. Below is a chart with some data on that.
This is fun! (I know I need to get out more). Talk soon, Fil
P.S. I don’t think I understand what this comment means: “ Then the other thing is you have to look at buybacks not just in gross $, but as a % of total market cap out there. Market cap and multiple on some of these companies is so high now, they are no longer reducing share count with their buybacks”
Thanks for the research and concise presentation. As a novice in the bond market world, I wonder where can one obtain data on investment and high yield credit spreads?
Let's get the comments rolling with this one from a friend, who never posts anywhere but who is never shy with an opinion:
Who knows what the market will do but not sure he is right about this. When interest rates were 0%, you borrow to fund buybacks, because it is accretive. Apple prime example.
Now if you have to borrow at 5%-7%, and your PE is 20 or more, the buyback is not accretive to EPS. That would be dilutive.
So obviously, there is still borrowing going on, but that is probably to fund operations as opposed to fund buybacks.
Obviously there are still buybacks going on too, but they are being funded by the cash already borrowed previously (but not used up yet), or by cash from operations.
Anyway, my point is I wouldn’t draw too much linkage now between the debt markets and buybacks.
Then the other thing is you have to look at buybacks not just in gross $, but as a % of total market cap out there. Market cap and multiple on some of these companies is so high now, they are no longer reducing share count with their buybacks.
Then as you point out, they are announced, but always hard to know the rate at which they will happen.
My 2 cents, market could go up, could go down, but I do not think buybacks funded by the current debt market will be part of why.
Fil responds: don’t necessarily disagree that higher rates on the margin deter borrowing for buybacks, but the point I was trying to make is that the willingness of credit markets to lend to companies who might want to do buybacks is key. If the credit markets are shut, many companies won’t spend their cash on buybacks because they don’t want to be caught short for other purposes. So the whole buyback process shuts down completely. If credit markets are in good shape, maybe cos will borrow for buybacks or maybe they only use their cash, but the buyback desks will kick in if they have the mandate. In other words, “money is fungible”… but only as long as it is available.
A couple of other points: yes, if borrowing costs are too high relative to the valuation of the shares it may not make sense to carry out buybacks. But valuations are fluid: is the company only looking at today’s valuation? What if they expect fast growth? What if their capitalization is mostly equity and their equity cost of capital is very high because the market is skeptical of the company’s outlook/operations? Calculating equity cost of capital is hardly a science and many CFOs may well be inclined to bring down the WACC with some debt for buybacks.
As to the actual costs of borrowing, and this is important with respect to distinguishing between IG and HY companies, the borrowing rate mentioned by your friend is way too high even at “currently high” base rates (I used quotes because I am also old enough to remember 15% treasury coupons). When cos borrow expressly for buybacks or “general corporate purposes” (which often includes buybacks) they use short dated debt, usually no more than 3 years. If you want to use CAT as a proxy, which is “A” rated (only 2 steps above junk) but has a pretty hefty amount of debt and patchy FCF, in August it sold 3yr bonds at 4.4%. Or take Oracle, a BBB (so technically junk) which also has a lots of debt but also much steadier FCF, its 3yr bonds trade at 4.1% right now.
Lastly, yes companies can announce buybacks and not go through with them, but unless something drastic happens on a macro level, most generally do. Below is a chart with some data on that.
This is fun! (I know I need to get out more). Talk soon, Fil
P.S. I don’t think I understand what this comment means: “ Then the other thing is you have to look at buybacks not just in gross $, but as a % of total market cap out there. Market cap and multiple on some of these companies is so high now, they are no longer reducing share count with their buybacks”