What are share repurchases?
The coronavirus pandemic has thrown a number of industries into disarray, leaving companies with mounting debt piles from loans and government bailouts.
In a bid to shore up finances and repair balance sheets, a number of firms have recently announced share repurchases.
What are they?
A share repurchase, or share buyback, is when a company rebuys its own shares and returns money to its investors.
The issuing company usually acquires its own stock by distributing cash to existing holders, paying the market value per share, in exchange for a portion of the company’s outstanding equity.
When a company repurchases its own shares, this reduces the number of shares held by the public.
Companies can purchase the stock on the open market or from shareholders directly.
Why do companies do this?
Share buybacks from S&P 500 companies hit a record $806bn (£594bn) in 2018, with Apple (AAPL) and Bank of America (BAC) among the most prolific users of repurchases.
Although they have fallen since, they remain at historically high levels. In the UK dividends are worth three times more than buybacks, on average, according to researcher Link Group.
Read more: TUI to raise €1bn after boost in holiday bookings
One of the reasons behind share repurchases, particularly as seen during the coronavirus pandemic, is to enable a firm to reduce debt, shore up its finances and consolidate ownership.
However, it also provides a more flexible way of returning money to shareholders as an alternative to dividends. Public companies have a goal of maximising returns for their investors, so if a firm is generating more cash than it needs to fund its operations, buybacks are a good option for excess cash.
Share repurchases also increase the company’s equity value, and help businesses to look more financially attractive to investors.
If a board feels that its company’s stock is undervalued, buybacks are one way to solve this, and are often seen as an expression of confidence by the company.
Not only do they provide an additional exit route to shareholders when shares are undervalued or are thinly traded, but also prevent unwelcome takeover bids.
However, as they are typically financed with debt, it can sometimes strain cash flow.
Watch: Tesco raises outlook and will buyback shares
How do they work?
As share repurchases cut the total number of shares outstanding, and the total amount of cash on the firm’s balance sheet, this affects several metrics used by investors to estimate a company’s valuation.
Some of these metrics include earnings per share (EPS), a measure used by investors, and the price-to-earnings ratio.
Fewer shares in circulation increases a company’s EPS, and a higher EPS normally means a higher share price.
Recent share repurchases
Supermarket chain Tesco (TSCO.L) has launched an ongoing share buyback programme, and announced on Wednesday that it will hand £500m ($678m) back to shareholders.
Britain’s largest grocery chain said the move was not a defensive strategy to ward off a private equity bid, as rival Morrisons (MRW.L) is being taken over by US private equity group Clayton, Dubilier & Rice (CD&R).
“This isn’t defensive by any means, this is completely as far as we’re concerned part of business as usual,” Ken Murphy, chief executive, said.
“This is part of a very clear policy and is the result of the very strong cash flow we’ve generated and we’ve spoken to shareholders for some time about the possibility of buybacks when our debt ratios and our cash flow permitted.”
Read more: Morrisons bidder reaches agreement with pension trustees
Separately on Wednesday, Tour operator TUI (TUI.L) said it was also planning to raise €1.1bn (£940m, $1.3bn) by selling new stock.
It is the latest travel firm to tap investors for cash after airline Deutsche Lufthansa (LHA.DE) said it is also aiming to raise €2.14bn in a rights issue to help reduce a government bailout package.
Similarly, EasyJet (EZJ.L) revealed a £1.2bn capital raise last month.
In a statement on Wednesday, the Anglo-German company said that the share sale will allow it to decrease its draw on a state-backed rescue loan to zero. The sale will be offered at a discount price of €2.15 each.
Mark Baker at 5i Research said: "Companies have more room to divert future surplus capital to buybacks."
"Companies aren’t necessarily the best judges of their own value so they can squander cash on high share prices. And some, especially in the US, have resorted to borrowing to keep the buyback bandwagon rolling.”