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Buybacks are bunk
An excessive amount of options is causing techs to repurchase shares regardless of the cost.
March 11, 2003: 12:41 PM EST
By Paul R. La Monica, CNN/Money Senior Writer

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NEW YORK (CNN/Money) Tech companies still are riding the buyback train.

During the last three months, we've seen share repurchase announcements from the likes of tech heavyweights Qualcomm and Texas Instruments as well as some smaller names (flyweights? bantamweights?) such as Logitech, Scientific Atlanta and EarthLink.

Buybacks tend to be greeted by investors as a positive sign. For one, if a company agrees to buy back shares, it must be signaling that it thinks its own stock is a value, right? And if a company is repurchasing stock, that should lower the total number of shares on the market, also a good thing since it should help boost earnings per share.

Insert healthy dose of skepticism here.

Not really a bullish sign

The buyback isn't all it's cracked up to be. That's because many high-tech companies still, even in this day of ber-skepticism about the prospects for tech stocks, tend to lavish sizable amounts of options on their employees. When those options get exercised, the company's share count increases.

"Many tech firms talk a lot about doing repurchases, but if you look at their net issuance over time their actual share count goes up," says Ken Broad, co-manager of the Transamerica Premier Growth Opportunities fund and an outspoken critic of options. "Repurchases don't do a whole lot if share count continues to increase."

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Broad cites PeopleSoft (PSFT: Research, Estimates) and Cypress Semiconductor (CY: Research, Estimates) as two companies in particular that have seen their share count increase over the past few years despite stock repurchases. He does not own either stock in his fund.

What's more, as I pointed out last month, tech insiders haven't been stepping up to the plate to buy up shares of their companies. If companies were really bullish about their outlook, it would be nice to see corporate buybacks coupled with insider buying. That's not happening.

Buybacks are not inherently bad. Cisco Systems (CSCO: Research, Estimates), for example, announced in February that it bought back $2.6 billion worth of shares in the first half of its fiscal year (August through January). The number of fully diluted shares has decreased by 124 million shares during that time frame.

But based an average price of $13 a share for Cisco during that time, the company should have been able to reduce its share count by 200 million shares. So there had to be some new shares that hit the market through options exercises as well. Not surprisingly, Cisco is one of the staunchest defenders of keeping options-related expenses off of a company's income statement.

Should options be expensed?

That brings us to another hot topic at hand. The Financial Accounting Standards Board (FASB) is scheduled to vote Wednesday on whether or not to put the issue of expensing stock options on its next agenda. Currently, the cost of options is not subtracted from a company's net income. So critics contend that tech companies that use a lot of options appear more profitable than they really are.

If companies suddenly have to start listing options as an expense, they might give out a lot less of them. That would be good news for the sector because even some of the best-managed companies in tech have had to resort to major buybacks, regardless of the stock price, due to prolific options grants.

Look at Dell Computer (DELL: Research, Estimates), for example. It reduced its share count by only 26 million shares, or just 1.7 percent, from the end of fiscal 1999 through the end of fiscal 2002, even though it spent $6.7 billion to buy back 189 million shares during that time frame.

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That works out to an average price of $35.45 a share. Dell's stock now trades for just $26 a share. "Buying your stock back when it's overvalued does not make sense," says Alex Vallecillo, senior portfolio manager with National City Investments, subadvisor of the Armada family of mutual funds.

Clearly, this isn't as much of a concern as when tech stocks were trading at truly absurd valuations in the late 1990s and 2000. But if companies have to use cash to buy back stock, even with tech stocks at current levels, simply to offset possible dilution from options, shareholders have the right to be a little annoyed. That cash could be used for other purposes such as funding research and development, acquisitions, or dare I say it, paying a dividend.

Companies should buy back stock when the price is right, and not as a last resort to counteract a deluge of new shares that will hit the market because of excessive options grants.  Top of page




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.