Data: Comparing Stock Buybacks (#6) - Plus Applied Materials Case Study

Abstract

Stock buybacks to capitalize on undervaluation make sense, but, in combination with option plans, they may fall prey to the law of unintended consequences. Buybacks use shareholder cash to increase the ownership stake of management (and employee) options. Returns to option holders are substantially richer from buybacks than from reinvestment and always far better than a dividend. An Applied Materials 2004-2007 case study extends a series that quantifies buybacks' skewed returns in favor of management options. Applied spends $6.4 billion to repurchase 20.9% of its shares. Its stock rises 11.7%. The direct result is a $0.36 (1.8%) pretax benefit per share versus securing a $4.12 benefit per option. Apparently, the board saw cash payout as preferable to reinvestment. Did the board's execution adequately balance competing interests of shareholders and option holders and weigh potential corporate trading liabilities? The Applied case is similar to other, recent company buyback studies: Alternative buyback return measures are discussed, absolute accretion is presented as a preferred measure, and divergent returns to shareholders and option holders due to payout decisions are calculated. Option holders are observed to earn hedge fund type 2/20 fees for work on buybacks. In addition, a buyback comparative analysis framework is expanded to include Applied Materials. Ideally, the data presentation will be extended to cover an entire industry to assist boards in adherence to governance best practices and aid shareholders in their assessment of a buyback's likely outcome.