An Aggressive Style of Share Buyback Is Having a Moment | Mint

An Aggressive Style of Share Buyback Is Having a Moment

An Aggressive Style of Share Buyback Is Having a Moment
An Aggressive Style of Share Buyback Is Having a Moment

Summary

It’s shaping up to be a bumper quarter for accelerated share repurchases after both General Motors and RTX made punchy bets on their own stock.

In a cooling market for share buybacks, $10 billion commitments from both carmaker General Motors and aerospace-and-defense giant RTX stand out for their irreversibility as well as their headline value. The companies had better be right that they won’t need the cash.

RTX and GM have both entered into blockbuster accelerated share repurchase agreements with banks in recent weeks—an aggressive form of buyback that requires sending all the money out of the door at once. Thanks to these transactions, ASRs are on track for their second-best quarter since the start of the pandemic, according to data provider VerityData. Health-insurance provider Cigna is also planning an ASR next quarter as part of a $10 billion buyback program following the collapse of its anticipated tie-up with Humana, it said Sunday.

Buybacks make sense if companies have accumulated more cash than they pay out in regular dividends or can profitably invest, and if their shares are undervalued. While politicians worry about the tradeoff with investments, the valuation condition is the problem for shareholders. Big companies are typically more focused on return of capital than return on capital, says Ali Ragih, a senior analyst at Verity. They cut buybacks after the pandemic stock-market crash of 2020, for example, only to ramp them up as shares got more expensive.

That said, the latest ASRs look to be exceptions. Both RTX and GM shares were close to multiyear lows when the companies launched their programs in late October and late November, respectively, following runs of bad news.

GM’s stock was trading at four times earnings, hit by a protracted strike and delays in its electric-vehicle and driverless-taxi programs. RTX, the company created from the 2020 merger of Raytheon and United Technologies, had been blown off course by a recall of Pratt & Whitney engines. Its market value declined by roughly $36 billion between disclosing the problem in July and its ASR announcement. By comparison, the company estimated the hit to its profit at $3.5 billion.

The bigger questions for GM and RTX might be around their financial resilience, particularly given the front-loaded ASR structure.

Companies more typically commit to buying back shares on the open market over an extended period, which gives them maneuverability if conditions change. ASRs instead involve contracts with investment banks, which typically undertake to sell the company a large chunk of stock upfront at a set price and then more shares later over the course of as long as a year.

The approach lends itself to news splashes and strong share-price reactions, as investors can be sure a meaningful number of shares will be immediately retired. GM’s stock rose 10% on the day of its announcement, while RTX’s was up 7%. The downside is that RTX and GM can’t backtrack if conditions change and they end up needing cash.

GM should be fine as long as the economy doesn’t tank. Its balance sheet is strong: Stripping out the $10 billion ASR, it would still have had $2.6 billion of net cash on its balance sheet at the end of the third quarter. But cash disappears quickly when carmakers run into problems, and GM will have less room to accelerate its technology bets if they show more promise next year than they have in 2023.

While defense contractors are less sensitive than automakers to macroeconomic conditions, RTX has more financial risk than GM, having funded its ASR by borrowing. Moody’s and S&P both cut their debt-ratings outlooks for RTX to negative from stable following the buyback announcement.

A more technical question with ASRs is whether companies get the best value for buybacks by giving a bigger role to Wall Street. After the initial tranche of buybacks, the complex transactions are structured such that banks have incentives to maximize their own return rather than to buy as many shares as possible, says Michael Seigne, a U.K.-based buyback consultant to boards and companies. This effect might counteract the benefit of what looks like good market timing at GM and RTX.

While flexibility is usually an advantage of buybacks compared with dividends, it is the very inflexibility of ASRs that made them appeal to GM and RTX. If 2024 throws up nasty surprises, their executives will have nobody to blame but themselves.

Write to Stephen Wilmot at stephen.wilmot@wsj.com

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