Special Report: Share Buybacks - Who really wins?

Provided by The Australian Investor

Tuesday 17th July 2001

It's amazing how the market leaps aboard whenever anything like a trend drives by. 1999/2000, it seems, was the year of the biotechs. The year before, the dot coms. This year, 2000/2001, is the year of the buy back. In July last year, the Australian Financial Review predicted with some awe that buy backs for 2000 would be worth around $5 billion. By January this year, the market had been deluged with over $11 billion in share buy backs, over the previous twelve month period - more than double the prediction in mid-year.

The commonly stated function of the buy back is to return excess capital to shareholders. As such, Lend Lease, flush with cash after the $4 billion sale of MLC to the National Australia Bank last year, felt that this money would sit better in shareholders' pockets than slumbering in the company's bank accounts. Whether it's lack of imagination, or outright generosity on the part of the company is a moot point. However, a decent offer price, plumped up with a healthy dividend, as well as the possibility of additional tax and capital gains breaks (the LLC offer was actually $7/share and a $12.88 dividend payment, allowing for a capital loss to be recorded on the share price) can present an easy choice for most. LLC shareholders who accepted that company's offer of $19.88 per share offer in October last year did very well as the share price now malingers around the $12 mark.

One important feature of buy backs is the fact that they concentrate equity. By decreasing the number of shares on offer, buy backs automatically raise the value of those remaining shares (if perhaps only briefly). Not only does this refer to currently existing shares, but also, of course, to options as well. With regard to the latter, the executive sector has more than a passing interest. Options for directors among the top 100 companies constitute, on average, a gross value of around $6 million each. Overall, options account for around 80% of top executives' total remuneration package. As such, it may not be unjustified to question whether boards, especially among the top companies, are making buy back decisions with their own options packages in mind.

A second consideration, also in relation to the concentration of equity, is the governance implications of buy backs. It is interesting to note that among the most prominent buy backs are companies, which have relatively open registries.

For instance, the Commonwealth Bank of Australia has recently announced an offer to buy back $700 million of equity to add to an offer for a $200 million offer already in operation. The CBA registry, as a remnant of its status as one of the first big government-to-public floats in the 1980's, is very open in comparison to other major companies in Australia. In FY2000 its top 20 shareholders controlled just 34.69% of equity, a very low figure among the top 100. Another company, NRMA Insurance, which has just closed an offer to buy just over $400 million in shares, had an extraordinarily open registry prior to the buy back. The top 20 shareholders held just 13.35%, the lowest figure in the top 100 companies in Australia.

In both cases, it is not unreasonable to assume that the difficulties a more open registry may present for either board, particularly in an era of increased shareholder mobilisation, were part of the foundation for the final decision to initiate a buy back. For CBA, the potential would have been far more acutely felt, as the bank has been targetted by its own employee shareholders and union groups at recent AGMs. For NRMA, in the wake of its risible board performance since the company's float last year, an active and critically engaged share registry may loom as a real threat to the board's ability to maintain the trust of its many small shareholders.

The ability of buy backs to concentrate registries is further added to by the fact that the most enthusiastic acceptors of the plans are usually smaller shareholders, motivated by the short-term benefits offered by the buy back plans. Institutions usually have longer running strategies and/or are commonly tied to indexes, both of which militate against their greater take-up of share buy backs.

The possibilities for greater board control, generated by a more concentrated registry, cannot be ignored by company management. The potential for 'cleaner' registries, made up of more institutions with proportionally larger blocks of shares, presents a very attractive scenario for many board members seeking ways to make the decision-making process smoother, and, perhaps, less accountable. In an era that is becoming marked by shareholder awareness and anti-corporation activism, the buy back offers an opportunity to shave off smaller, messier shareholders These considerations would not have escaped those many companies currently offering or about to offer buy backs.

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