Stock Buybacks – Learning from the Henry Singleton Playbook

When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases. – Warren Buffett, 1984 letter to Berkshire Shareholders

A stock buyback, also known as a share repurchase, occurs when a company offers cash to its existing shareholders in exchange for its own shares, thereby reducing the number of its own shares outstanding and increasing the per share value of the remaining shares. This option is one capital allocation decision available to the management of a company that will benefit its shareholders if executed at the right time, which is as Buffett points out when the shares sell below intrinsic value in the stock market

To see how this was utilized in practice, we turn back the pages of history and look at a masterstroke effected by Dr Henry Singleton, the CEO of Teledyne, who not only was a shrewd acquirer of businesses, but practically pioneered the idea of stock repurchases as a means to enhance shareholder value. For those of you unfamiliar with Singleton, he was the Gavaskar to Buffett’s Tendulkar, the original conglomerate king as it were, earning the respect of Buffett himself who once said that “the failure of business schools to study men like Singleton was a crime” and calling him the greatest capital allocator in the history of American business.

Dr Henry Singleton

In the bear market of the early 1970s, Teledyne’s share price fell from $40 to about $8. Dr Singleton believed his own stock had become grossly undervalued, saying the following

“In October, 1972, we tendered for one million shares and 8.9 million came in. We took them all at $20 and figured it was a fluke, and that we couldn’t do it again. But instead of going up, our stock went down. So we kept tendering, first at $14 and then doing two bonds-far-stock swaps. Every time one tender was over the stock would go down and we’d tender again, and we’d get a new deluge. Then two more tenders at $18 and $40.”

Teledyne history under Singleton

Teledyne history under Singleton

At the time, very few people understood the genius of what Dr Singleton was doing. Teledyne’s profits continued to grow at a steady rate, but over the period shares outstanding dropped over 90% over the 1972 to 1984 period, causing the earnings per share to compound at 40% and profits to compound at 21%.

Some Technical Details of Buybacks (Section 68 of Companies Act, 2013)

  1. Shares are repurchased either out of free reserves , share premium account or the proceeds of the issue of shares or other specified securities, provided it is not made out of proceeds of an earlier issue of the same kind of shares or same kind of other specified securities. This means that you can issue preference shares to buyback common shares, but can’t buyback common stock with an issue of common stock
  2. In Indian GAAP accounting, shares repurchased must be extinguished within 7 days of last completion of buyback. This is in contrast with USA GAAP where Treasury stock is created in the event of a buyback.
  3. Sources of buybacks
    1. Tender offer from shareholders
    2. Open market: Book building process or buying from stock exchange
    3. Purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

In 2013, SEBI tightened buyback norms in India, in particular specifying that –

  • Companies must purchase at least 50% of the offer size, failing which they will have to forfeit 2.5% of the total amount earmarked
  • Companies would not be able to raise further capital for one year from the closure of the buyback or make another buyback offer within a period of one year from the date of closure of the preceding offer
  • Maximum buyback period reduced from 1 year to 6 months

In recent history, one buyback scheme in the Indian markets that garnered quite a bit of attention was Hindustan Unilever in 2013, when Unilever PLC, the parent company increased its stake from 52.48% to 67.25% of the total share capital of the company, offering Rs 600 a share at the time. You can refer to this paper for details.

Conclusion

Buybacks are not very common in India because we lack many mature companies compared to the US markets, and usually promoters and management prefer to pay a dividend or reinvest earnings. However, it has become quite a regular occurrence for US blue chips to retire a portion of their shares outstanding on a frequent basis. Be warned that not all buybacks add value, and a buying back expensive stock will destroy shareholder value. Buffett pointed out the same in a 2009 Berkshire shareholder meeting –  Ninety percent of repurchases in the last five years were at silly prices and not in the interest of shareholders. Managers did it because it was what everyone else was doing. It’s interesting how many companies bought at two times current prices that aren’t [buying] now.  

Lets hope more Owners and CEOs learn from Singleton and Buffett.

 

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