Don’t forget, too, that buying back stock means that you have it available in the future should you find good opportunities and have a good market for your stock. Most corporations don’t want to issue all the possible stock they could. Having series available for sale means you can get investment cash when you need it.
Agency theory shows that signaling via a stock repurchase or a one-time special dividend doesn’t work nearly as well as signaling through a dividend increase. Isolated cash outlays merely suggest the obvious: the company has too much cash for some reason or other. A dividend increase, on the other hand, is a real commitment and a much stronger signal. This is because a future reduction in a dividend is a VERY negative signal, so management wouldn’t increase the dividend unless they are absolutely certain that it could be maintained in the future. I know that much of this reasoning is circular, but this is the thought process when there is an asymmetry of information between management and shareholders.
Having a large amount of excess cash is a significant cost to a corporation, especially when interest rates are so low. If a corporation earns 10% on its internal and external investments, but cash accounts for 20% of its balance sheet, it now has to earn 12+% on its investments. This can’t be done unless it takes on more risk (which the market would quickly discount for anyway). Cash sitting on your balance sheet doing nothing is a waste of shareholder capital. Stockholders can earn money market returns through their own banks if that’s what they want. They don’t need IBM to do it for them. Proper financial policy is to give any cash that a company doesn’t need back to its investors. There are only 3 ways to do this: 1a) buy back stock, 1b) pay out a dividend or 2) buy back debt. 1a and 1b would reduce your stock investment while 2 would reduce your debt. Since debt is cheaper than stock, healthy companies typically want to reduce stock. Companies that have become over-levered (i.e. they have too much debt) would seek to buy back debt. Companies typically try to maintain a capital structure (mix of debt and equity) that minimize their overall cost of capital.
I haven’t researched IBM lately, but could probably guess why they had so much excess cash. About 2 years ago, the financial markets and economy were in turmoil. Companies didn’t know that the public debt markets would be available to them (and at what cost) should they need more capital. Plus, their future revenues were in jeopardy. So many of them started hording cash to prepare for difficult times (much the same way that the public in general did, since workers’ jobs were in jeopardy and no one would loan them money). Companies were certainly conscious of the high price of holding cash, but felt that the cost was worth it given the uncertainty. Luckily, government market intervention has reduced the duration and magnitude of the credit crunch. Companies are once again confident that there is sufficient liquidity and risk appetite for future funding.
One reason to have excess cash is if you know that you’ll be using it soon. If you plan on making a large acquisition, capital expenditure or investing in a large project or joint venture, you probably want to have the cash available so that you can move quickly. IBM may have also had something like this in mind.
I forgot to add that share repurchases are always more tax efficient than dividends. In the cash of a repurchase, the seller already had some basis in the stock and only has to pay taxes on the “gain”. The dividend receiver has to pay taxes on the whole amount.
It’s called taking the company private.
That is, instead of being a corporation, with stock publicly traded on some stock market, they are a privately-owned corporation. They no longer have to file SEC reports, publish annual stockholder reports, etc. Much less information is publicly available about them.
Many corporations start out as private (for example, the founder & spouse), as they grow they take in others to get money to grow the company, and then eventually make a public stock offering on a stock exchange. Going private is the reverse of that, and is much less common.
But if the company buys up ALL its own shares, who owns it?
I don’t think it’s possible for a company to purchase all of its outstanding shares in the real world. For one thing, the value of a company’s outstanding shares would presumably be higher than all of the company’s cash on hand because the latter is part of the former.
What does happen is that a private band of investors (whom may or may not already own a significant portion of the company) purchase the rest of the outstanding shares of the company and take it private.
(Oh, and what happens if by some quirk of fate the value of a company’s outstanding shares falls below its cash on hand? The investment community tends to notice that sort of thing almost instantly and would bid up that company’s shares pretty much immediately.)
Much higher. Most of a company’s value comes from expected future cash flows. And the stock price is based on the market’s view on the growth or reduction of these future cash flows.
Which, in essence, is simply replacing the equity with debt…and which is why its typically called a “leveraged buyout”.
The only way that this could happen if there is some known large cash outlay in the future, such as a legal settlement. This cash is labeled as “reserved cash” and is typically held in escrow.
This, plus: if a company has an employee stock purchase plan (ESPP) to encourage literal and figurative “buy-in” by employees to the financial success of the company, it needs shares for the employees to buy. There is often some discount from the market price for these programs, so the company buys volumes when it feels the shares are undervalued. Good for the company and for the employees.
Whoever they bought the shares from has the money.
Really surprised that nobody has mentioned the most common reason yet. Usually stock buy-backs are so the company can offer stock and stock options as compensation to employees.
For various reasons, companies usually prefer to give a bonus of in stock or stock options rather than an equivalent value in cash. The company could simply issue new shares of stock, but that reduces the value of currently outstanding shares and lowers your earnings per share ratios, etc. So instead, the company has to buy shares on the open market first and then give them to the CEO or vice presidents.
Case in point – check out the number of shares that Microsoft has bought-back over the past 10 years. (It’s huge). The check out the number of shares of Microsoft outstanding (it’s still the same now as it was 10 years ago). All those stock buy-backs were just used to give options to employees
What happens if one blue-haired old lady in Idaho wants to hold on to her 4 shares? Can you really buy back EVERY single share?
Not sure how it works in the US, but in the UK if one person/entity manages to buy a certain percentage of the shares (59% rings a bell) of a public company, they can force everyone else to sell to them also.
Voyager mentioned this in post 12, although he believes that this reason is less common these days.
In France, it’s almost the reverse : they must offer to buy all remaining shares.
Regarding the “company buying back all its shares” thing. I once asked this (long ago) to a professor of mine, and he told me that besides being highhly unlikely to be possible in practice, it was forbidden under French law. Besides the obvious issue of ending up with a company without any owner, he didn’t say (or I don’t remember) if there was any specific reason for either forbidding the practice or even attempting to do such a thing at the first place (But given how imaginative bussinessmen can be, I wouldn’t be surprised if one could achieve some undesirable goal by doing such a weird thing)
It might be the same thing. If someone wants to buy 30% or more of a company, they must make an official offer to everyone first, and if greater than the magic percentage accepts, the remainder can be forced to sell. I was wrong about the magic percentage in my previous post - it is actually 90%