Buybacks have put US corporations deeper in debt. Net US corporate debt is a record $2.3 trillion, up 14% in the last year alone. The combination of too much debt, slowing earnings and expensive shares are slowing the buyback stampede
The combination of free money and incentives for management has been irresistible for many corporations in the US. In the 12 months to 31 March 2014, US companies increased their spending on buying their own shares by 29%. Then bought $534 billion worth. This was surpassed on in 2007 when companies bought $589 billion. These buybacks have helped the US market reach new highs and increased earnings. So any end to the process may have a dramatic impact.
Buying a company’s own stock is the classic strategy for managers who can’t think of anything more productive to do with their cash. By reducing the number of shares outstanding they make earnings look better. There are more earnings for fewer shares. Increased earnings usually raise the price of the stock. Since managers are often on incentives to raise share prices, buybacks can look very attractive. They can be even more attractive when the corporation can borrow at rock bottom rates to purchase the shares.
Buybacks are also popular with shareholders. There is even an exchange traded fund (ETF) for them. PowerShares Buyback Achievers has returned 22.7% per year compared to 18.8% for the S&P. But there is a problem. Although the process does flatter earnings, it also increases debt. Often corporations are using debt to purchase expensive shares. So it is no way to grow a company.
Philip Morris, the American tobacco company is one example. Over the past five years, Philip Morris has been able to grow its earnings by more than 10% even though sales were flat. Higher earnings were created by price increases and cutting costs, but these were not sufficient to send its earnings into double digits. What did that were buybacks.
Since 2008, Philip Morris spent $56 billion on its own shares. This large amount did not come out of its $43 billion if cash flow. They had to borrow another $14 billion to pay for it. Without income and increasing debt, Philip Morris’s credit rating might be at risk unless as its chief financial officer (CFO) states, the company “will have to bring our cash outflow in line with our inflow”. In other words they will no longer be able to spend $2.7 billion more than their income on buybacks and dividends. No doubt there will be an impact on their stock.
It is not just Philip Morris. Buybacks have put US corporations deeper in debt. Net US corporate debt is a record $2.3 trillion, up 14% in the last year alone. The ratio of long term debt to assets is almost as high as it was at its peak in 2009. Profits have not kept up. The awful first quarter reduced profits by $198 billion and net cash flow by $120 billion. Commentators love to blame this on the weather, but overseas profits were also hit by $26 billion.
So, buybacks will probably slow because managers have maxed out the corporate credit card. But there is another better reason. It no longer makes sense. There might be some economic basis for purchasing undervalued shares, but it is just incompetent to buy them at the present valuations. US markets are trading at all time highs. Tobin’s q, a well regarded index of valuation, puts equities at 88% overvaluation. Robert Shiller’s cyclically adjusted price earnings ratio (CAPE) puts the overvaluation at 87%. Buying expensive stock with more debt is not generally a good business plan.
Analysts always lower earnings expectations as the year goes on. This one is no exception. Second quarter growth estimates have been lowered from 3.5% to 2.8%. The combination of too much debt, slowing earnings and expensive shares are slowing the buyback stampede. The number of US companies announcing plans to buyback shares in June was only 38 the lowest since 2011. The amount spent on buybacks last month was only $22.2 about a third of the $61.7 billion spent last June. Even the ETF Buyback Achievers is beginning to notice. It gained 8.5% this year compared to the S&P’s 14.9%.
Eventually even the present bull market will correct. Eventually interest rates will go up. So eventually buybacks will stop. Then corporate balance sheets loaded with debt will not look so attractive to anyone.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)
RIL is shooting off legal notices at the media while government is not yet doing its bidding
At its annual general meeting (AGM) in June this year, Mukesh Ambani spelt out the mega vision and global plans for India’s largest private sector company. Reliance Industries Limited (RIL) rides India’s economy with a giant presence in multiple areas. Yet, unlike a decade ago, the chairman’s speech never once harped on how it is the ‘world’s biggest’ in any of its areas of operation.
Maybe RIL has turned quietly confident, or maybe it finds it prudent not to tom-tom its giant footprint across four areas that are core to India’s economy—oil & gas; petroleum refining and downstream petrochemicals products (where RIL ‘enjoys global rankings’ in most categories including the largest gas cracker in the world and the largest refinery system at one location with integrated logistics); retailing, where it is fast moving to market leadership in a slew of categories including food, apparel and household products; and telecom, where it wants to be a global leader in delivery of digital content, applications and services.
RIL’s AGM is also no longer the mega-event it used to be in the mid-1980s for investors or the media. In fact, the much smaller Infosys receives significantly greater coverage for every change and announcement that it makes, probably because investors are more interested in it. It could also be the fact that, at every step, Reliance is dogged by controversy and, over the past two years, has spent more time alienating the media.
The big change in sentiment began around the time that the maverick Arvind Kejriwal decided to fast-track his political career by setting up David vs Goliath situations with mixed results. He was spectacularly successful in the city-state of Delhi by accusing a three-time chief minister Sheila Dixit of corruption and mismanagement. It was an exaggerated charge but worked with the masses; Mr Kejriwal dropped the allegations as soon as his mission was accomplished.
In business, he targeted Mukesh Ambani and the mighty Reliance group. He created the initial shock and awe with his allegations and attracted an army of impressionable, but passionate, youngsters. He also impressed a core support base of important editors and top television anchors who were integral to the stupendous support and sympathetic coverage that Mr Kejriwal’s anti-corruption agitation received. But more about that later.
When it came to politics, a charitable view would be that Mr Kejriwal quickly realised that the 2014 elections were not about the blundering incompetence, arrogance and corruption of the United Progressive Alliance (UPA) and chose to target Narendra Modi instead. Or, that he was squeamish about attacking Sonia Gandhi whose trust and confidence he had enjoyed earlier. The mistake of this strategy is not the subject of this column. Let us focus instead on Mr Kejriwal’s entire negative campaign plank—that Narendra Modi was in cahoots with industry, especially Reliance, and would work to their benefit, if elected.
Forty days after forming government with a historic mandate, none of Mr Kejriwal’s allegations have come true. Instead, we have a raft of positive decisions from Modi sarkar starting with disciplining government employees and powerful bureaucrats. Meanwhile, the bad news keeps dribbling out for India’s largest corporate group. The gas price hike, which was projected as the first possible move of the Modi government, has been postponed. Reliance has reacted by announcing that it will defer investments in developing newer fields like R-Cluster in KG-D6 block if the government does not hike gas prices to make production from them economically viable.
Reliance has also made news for these wrong reasons:
• The Securities Appellate Tribunal (SAT) rejected RIL’s attempt to compel the Securities & Exchange Board of India (SEBI) to settle an insider trading charge dating back to 2007 by filing consent terms. This would allow it to pay a fat fine without admitting to wrongdoing on the charge that is made an unjustified profit of over Rs500 crore by short-selling shares in the futures market.
• The Comptroller & Auditor General (CAG) has recommended cancellation of its 4G licence and spectrum allocation, alleging wrongdoing in fixing the eligibility criteria in the bidding process. Infotel Broadband Services Pvt Ltd (promoted by the controversial Himachal Futuristic Communications group) had won a pan-India 4G licence by bidding 5,000 times its net worth and was acquired by Reliance within hours of winning the bid, leading to obvious conclusions. It has been renamed Reliance Jio and is leading RIL’s telecom foray. The CAG’s draft report says that the vitiation of the auction process gave Reliance Jio Infocomm a Rs22,842-crore windfall. RIL has strongly denied CAG’s contentions and the department of telecommunications (DoT) has also supported it. Incidentally, Aam Aadmi Party (AAP) has demanded a CBI inquiry into this issue and has also filed a public interest litigation in the Supreme Court.
• RIL’s 4G services, that are supposed to revolutionise how we talk, view and share data, will be rolled out only in 2015. Mukesh Ambani announced a Rs70,000-crore investment for this business. Industry experts say that the lack of adequate, inexpensive devices and an ‘ecosystem’ to make 4G workable is an issue. RIL was planning to flood the market with cheap tablets and providing voice telephony free. Meanwhile, Mr Kejriwal has probably succeeded in forcing RIL to complete its Rs4000-crore investment in TV18 group (along with the ETV group). Those in the know say that RIL was primarily interested in the TV18 group’s content (TV, web properties and print products) for the 4G business. But its hand was forced when a string of AAP spokespersons kept up the unsubstantiated allegations against Mukesh Ambani and RIL as an indirect attack on Narendra Modi. That strategy seems to have boomeranged. It only acted as a strong rallying point for Narendra Modi’s supporters while hurting the top editors and television anchors who wore their support and sympathy for AAP on their sleeve.
• Mr Ambani, who has been awkward in handling the media, is not winning any friends by reacting like a wounded tiger. He has shot off multiple legal notices to journalists across the media for their reportage on gas pricing and other issues (including two to Moneylife editors). More importantly, he probably made history as the first media owner to slap defamation notices on his own editor-in-chief who is an employee and shareholder.
• Finally, the group, which was known for its powerful but hidden media influence, has hired a team of senior journalists to communicate its point of view directly to the public. These journalists sporadically battle critics on twitter and churn out YouTube videos and content on facebook and slideshare to explain and refute AAP’s many allegations on social media. A 56-page coffee table book called Flame of Truth has been produced as a counter to the Paranjoy Guha Thakurta’s 588-page Gas Wars which the company described as a ‘pamphlet’. Flame of Truth presents RIL’s view on gas pricing and exploration. Its highlight is a case study by the late CK Prahlad and RA Mashelkar.
Is any of it working? As a business journalist for three decades, I have learnt that public interest is superficial and rarely goes beyond a snapshot perspective about whether an issue is good or bad. Even in the Gas Wars case, while RIL has succeeded in silencing some media houses, there is now a paperback edition of the book; neither Flipkart nor Amazon have stopped sales and it continues to be discussed in social media.
None of this is good for anybody. Appearing to gag free speech by using its enormous financial clout bodes ill for RIL. No government can be seen to support this attitude—especially one that has promised better days to the people. But when this aggressive and negative strategy fails to work, it does even more damage to RIL itself.
Sucheta Dalal is the managing editor of Moneylife. She was awarded the Padma Shri in 2006 for her outstanding contribution to journalism. She can be reached at [email protected]
According to citizens and activists, the Maharashtra Police Bill formalises the very practices of unwarranted political interference with everyday police management that the Supreme Court has sought to reduce
A delegation of concerned citizens recently met Maharashtra governor K Sankarnarayan urging him not to give his assent to the Maharashtra Police Bill.
The Maharashtra Police (Amendment) Act (MPA), 2014, was passed by both houses of the state legislature on 14 June 2014. The government says they aimed to give capable and well managed police.
Earlier this week a delegation of citizens and activists, led by JF Ribeiro, former Commissioner of Mumbai Police, met the governor requesting him not to give his assent to the Bill, which they allege was passed in haste without due consideration.
After the meeting, Maja Daruwala, director of Commonwealth Human Rights Initiative (CHRI), told reporters that, “We have only been trying to press on the governor to use his powers under Article 200 of the Constitution to withhold his assent to this extremely bad Bill".
Dolphy D'Souza, convener of Police Reforms Watch in Maharashtra, said the Bill formalises the very practices of unwarranted political interference with everyday police management that the Supreme Court has sought to reduce. Hence, it must be overhauled to be made fit for purpose.
Even Prakash Singh, former director general of Police, in a letter, had mentioned that this law is important for decide the direction of policing in the state for future decades, however, the government has pushed it in little hurry without any public consultation. The citizen activists also forwarded this letter to the governor.
“Under the guise of complying with the Supreme Court’s directives on police reforms, the new Bill defeats the objective of giving the public a capable, well-managed and accountable police. It has diluted and even subverted each one of the six directions of the Court. The Bill in fact formalises the very practices of unwarranted political interference with every day police management which the Court had sought to reduce,” Singh had said in his letter.
Maharashtra Police (Amendment) Bill, 2014, passed by the Assembly, is to replace an ordinance which made amendments to the Maharashtra Police Act, 1951, to set the state on the path of police reforms. It is meant to incorporate the directives of the Supreme Court on police reforms.