Sure, explain to me how Kodak could not buy back all of it’s shares by selling it’s DI patents.
I’m with you, and think the people arguing that complete buyback is logically impossible are confused.
They will answer that the last shareholder will be irrational to sell – the fact the corporation has the resources to buy him out means their worth is more than they’re paying. The simplest way to falsify this argument is to consider debt: the corporation can be buying its stock with borrowed money. I think there are real-world examples of corporations with negative equity and cash on hand; the situation is then plausible, with the corporate officers and shareholder perhaps conspiring to defraud creditors. (This sort of fraud is commonplace, but I’ve never heard of shares outstanding going all the way to zero.)
There may be legal issues which undermine the concept. Yet it’s certainly not “logically impossible” and I find OP to be an interesting question.
I haven’t seen Kodak’s balance sheet, but if its patents are worth more than the market value of its stock, then it has a large amount of debt that must be paid off. Either that, or the value of its patents is not their market value, but rather some calculated value based on some kind of convention.
The reverse question is: Why would its market cap only be $575M when it has patents that are truly worth $3B?
To follow up, the total cash a company has is a portion of its enterprise market value (usually a small portion). As it converts its asset to cash, the cash portion will grow. But it can never get higher than the enterprise value, because the enterprise value will adjust for this cash. Typically, but not always, this would cause the enterprise value to drop. Much of its market value comes from investors’ opinion on the growth rate of its future free cash flows generated from its assets. As assets are converted to cash, the growth component of the future cash flows decreases.
It’s not unusual for a stock to trade at a discount to book. Perhaps shareholders think that the company’s assets are more likely to be paid out to insiders than to common stock holders. It’s not an unreasonable conjecture.
At any rate, under such a scenario a takeover becomes the method to unlock value.
I agree with JJ’s underlying sentiment though. Say there are 100,000 share outstanding and the company somehow buys back 99,999 of them. That last share is likely to have a controlling interest in the company (though not always). It’s likely that the value of the single remaining share exceeds the value of the company’s supply of cash: in other words, the company’s noncash assets have some positive value.
ETA: Ponder what happens to earnings per share as the number of shares declines.
I’d like to see a non-handwaving answer why it is impossible, if there is one. The market isn’t omniscient, and the market isn’t perfectly rational. “Proofs” that make the assumption that is is aren’t proof of anything.
Kodak has a long history of doing nothing with its patents. Kodak could have been a major force in digital photography if they had done anything with their research. But the $3B number comes from the silly amount of money that was just spent on the Nortel patents. It could be that Microsoft still has tons of money left that they don’t how to use and fork out $3B for the Kodak patents. But the $3B does not come from a team of technical and legal people reading all 1200 of the kodak patents and evaluating them base on current trends in the electronic industry. It comes from the $4.5B for the 6000 Nortel patents.
It seems to me that if a company gets down to one shareholder, and the company then buys that last share, then the company continues to belong in whole to that last shareholder, and nothing has changed. Companies are owned by people, and saying that a company itself owns something is really just legal shorthand for saying that the people who own the company own that something. So when the last shareholder sells his stock to the company, he’s really just selling it to himself.
The logical flaw is that the last shareholder is the corporation.
This isn’t a hypothetical. This is the actual situation with Kodak. See the article I linked to.
There is a patent buying frenzy right now, which has caused the value of those patents to soar dramatically. As gazpacho said, patents that Kodak failed to capitalize in the digital camera market are suddenly highly valued in the smartphone and tablet market. There’s one patent in particular (out of their 1100 digital imaging patents) which may generate a billion dollars in revenue.
For whatever reason, the market has not responded to that development. The price of a share of stock is not determined by a rigorous formula: it’s determined by the emotions of investors.
Most companies have a market cap that’s higher than its book value (assets minus liabilities) because investors take into account future growth. In the case of many tech stocks (like Apple or LinkedIn or Zynga), there’s a huge difference. In the case of Kodak, investors don’t see any growth.
This is typically when companies execute a stock buyback, when they think shares are significantly under priced.
I can only comment on Canadian corporate law, but the general rule in Canada is that a corporation cannot own its own shares. Section 33(1) of the Canada Business Corporations Act is typical:
There are some exceptions in the subsequent provisions of the Act, but even if a corporation is holding some of its own shares under one of those exceptions, the corporation cannot vote the shares, as provided in s. 33:
As well, some posters have commented that a corporation may buy its own shares to improve the value of the remaining outstanding shares. It’s important to understand that when a corporation does that, it is redeeming those shares, i.e. - cancelling them for value. See s. 36 of the Act. It’s not going to be keeping those shares as an investment.
If corporation and sole shareholder are fully equivalent, why do some doctors incorporate for tax/legal purpose?
I’m reminded of the fact, in mathematical set theory, that a singleton set and its element are unequal.
In one model of the natural numbers, 1 is a singleton set, but its sole element is 0 not 1.
For limited liability.
If kodak really did sell its patent portfolio for 3 billion in cash, the market capitalization would quickly shoot up and account for all that real liquid asset value, where as before the sale investors would have considered the worth of the patents as a theoretical (undervalued amount).
The limited liability arises because a corporation and its single shareholder are not equivalent.
This doesn’t say that a corporation can’t buy all its shares, just that they would all then be redeemed.
But, as mentioned above, this is only the general trend over time; the instant market price at time=T does not always logically and slavishly follow this rule at all times. E.g. a retrospective analysis this December might reveal that on Sep 21, 2011, IBM’s market price at 11 AM EST was 5% below the actual proportional value, and that on Sep 25 at 3 PM EST, the market price went to 10% over due to market frenzy. The market price may fluctuate due to rumors or just plain irrational behavior by investors, and the company could take advantage of that and buy their own stock when they believe that their market capitalization is less than the corporation’s “actual” value.
Also, the corporation could use shell entities to gather it’s own stock (e.g. form a spinoff or enter into a contract with another company to purchase it’s stock, making it more difficult for the market to realize that the corporation is gaining effective control over large quantities of it’s stock).
Also, the company could “come in” to it’s own stock through some other way, such as if, say IBM won a lawsuit against one of it’s biggest shareholders and seized the shares as satisfaction of the judgment. If the stock is held by only a few people, and the corporation sues them all at the right time, then I could see that it might happen that 100% of the shares are awarded to the corporation in satisfaction of the judgments.
And, simply saying that the company becomes private doesn’t make sense, because, if 100% of the shares become owned by the company, doesn’t that mean that the original owners no longer have their shares (e.g. they sold them to the company, or they sold them to someone who sold them back to the company).
I think Northern Piper has hit the nail on the head. A corproration may buy shares for various reasons (i.e. to give as bonus to executives, etc.) but it cannot vote those shares! That irrational last shareholder thus gets to pick the board and the president of the corporation at the next general meeting.
Typically, of course, the amount bought for these purposes are insignificant. If a corporation initiates a buyback to raise the value of the remaining shares, thenthey set a target of say, 5% or 10%. Note that any significant share acquisition of a publicly traded company must be declared. Someone doing a takeover must declare when they buy (IIRC) more than 5% of a company. Anyone seeking to “take over” must decalre their intent and offer to buy all the stock at a price, and then if they are succesful in getting more than 50%, they may buy all the other outstanding shares at that price. (Takeover rules can be complex). There are also a huge number of rules in place to protect minority shareholders if someone owns a controlling share.
But basically, a company seeking to buy back even 50% of its stock will have to declare that intent. Look at most stock takeover battles and the final selling price is typically well above the current market price, often almost double. (“Barbarians At the Gate”, IIRC the stock went from $45 to $109 by the time the deal was done.) The last few stockholders in a hypothetical self-buyback would know they had platinum-coated stocks, why would they sell? In a typical takeover, the majority holder can force a sale of the minority stocks, but in a self buy-back, the company cannot use/vote that majority.
As for book value - too true. GAAP say that an asset is typically carried on the books at its original purchase price. The new value only comes into play if the asset is sold or otherwise refinanced. Of course, independent valuations of a company may come up with a much different number than the books. Original valuation prevents the books from fluctuating with every up and down of the market or whim of the current assessor, but can fail to account for long-term trends. The typical examples were A&P or Greyhound, who carried their downtown properties at 1920’s purchase price even though by the 80’s they were worth a huge amount more. Investors going by book value would not see that the a $100,000 property downtown in 1920 was actually worth millions today.
Private companies are those not traded on a stock exchange. They still ahve shares, which might be bought and sold. (But there are strict rules too, on selling especially to the general public, without following various securities regulations). If a group (usually management or larger shareholder) thinks a public company’s stock is grossly undervalued, they may try to buy it and make it private (de-list it from the exchange.) This is not the same as a company buying itself. SOmeone(s) still own the stock, you just can’t buy it on Wall Street.
The final issue is fiduciary duty. The obligation of the executive and board is to maximize shareholder value. That is exactly their job, they are paid to do it. If they force, con, or persuade shareholders to sell shares back for less than what they perceive the value to be, are they serving the best interests of the shareholders? What conecivable argument could their be for a company to buy, say, 80% of outstanding shares?
There is one other logic bomb - share volume and price. IIRC, some exchanges will not tolerate shares going under $1 for any length of time. If a company hits hard times, they may decide to either buy back shares and shred them, or “un-split” their shares, trade, say, 10 for 1 of the new shares, so the price goes up. This is the opposite share splits - people are less likely to buy a share if it trades over $100, since it used to be you paid a huge commission for buying less than blocks of 100. When share price got too high, the company would split shares - 1 share is now 2 shares - to keep the price down. OTOH some companies went for snob appeal - our price is so high, our main investors are millionaires and billionaires. Since nowadays most shareholders are mutual funds and pension funds and discount brokers will sell less than 100-lots for low commissoin, such games are less relevant.
Also, IIRC, a company cannot pay dividends to itself on shares it holds. That makes the other shares that much more valuable.
It seems to me that we’ve got three sorts of obstacles to a corporation owning itself, philosophical, practical, and legal.
Philosophically, a corporation trying to buy itself from its stockholders is like a dollar bill trying to buy itself out of your wallet. But it is worth only $1.00, so to buy itself it would have to completely spend itself. Nothing would be left over. The problem with this objection is that companies frequently have assets that are worth more or less than their market capitalization, because the market is not perfectly efficient, and opinions about the value of a company differ. This is why people buy and sell stock, because they buyer and the seller have different opinions. So it is easy to imagine that in rare cases a company could have assets that are well over its valuation.
But we run into practical difficulties. One is that as the corporation buys up its stock, the value of that stock will rise. And when you’re down to one shareholder who owns the last outstanding share, that person owns the whole company, so why would they sell? But, we can imagine a corporation borrowing money to pay for itself. And all the objections based on the policies of various stock exchanges would make it very difficult.
Next we run into legal difficulties. And here we have some real teeth. Even if there’s no law that explicitly states that a corporation cannot own itself, there are other laws that have the exact same effect. The corporate executives are legally required to represent the interests of the stockholders. How could they have the company buy itself from the stockholders, therebuy showing that they believe the corporation is worth more than the stock value, without screwing over the shareholders? Plus there are all sorts of complicated rules and laws about how and when a company can buy and sell it’s own stock. Even if none of those laws explicitly state that a comrporatoin can’t own itself, they’ll have the same effect.
How would all these shareholder know the value of the stock was rising as the corporation bought them back? How would the market know? If the company was doing this quietly, how would the market know how to react?