Companies that borrow to buy back stock

[Fermion]

While reading this article http://finance.yahoo.com/news/stan-druckenmiller-sees-massive-problem-130107043.html I saw that Stan claimed companies borrowing money to buy back stock is nuts.

With the crazy low rates today, I don't follow him.

Example, Corning borrowed money at 1.5% to buy back stock. They pay a dividend of 2.2%. For every share they buy back, they get to keep 0.7% of earnings to grow a pile of money.

If I had a business with a partner, and the business paid us each 5% of its total worth each year in profits, would it be crazy for me to borrow money at 3% to buy out my partner?

 

[Sunset]

Heck if I could borrow money at 1.5% I'd by the entire stock market.

 

[dallas27]

While reading this article http://finance.yahoo.com/news/stan-druckenmiller-sees-massive-problem-130107043.html I saw that Stan claimed companies borrowing money to buy back stock is nuts.

With the crazy low rates today, I don't follow him.

Example, Corning borrowed money at 1.5% to buy back stock. They pay a dividend of 2.2%. For every share they buy back, they get to keep 0.7% of earnings to grow a pile of money.

If I had a business with a partner, and the business paid us each 5% of its total worth each year in profits, would it be crazy for me to borrow money at 3% to buy out my partner?

Yes, it would be crazy fro you to borrow money to buy out your partner. You should have the business borrow money to buy out your partner instead.

 

[GrayHare]

The risk levels are different. If cash flow problems arise, it's easier to shortchange the stockholders than the loan company.

 

[Big_Hitter]

“I think it’s nuts,” he said. “If you’re running a business for the long term, the last thing you should be doing is borrowing money to buy back stock.”


Has this guy ever studied corporate finance? Debt is one of the primary 3 drivers of ROE.

 

[Christine]

How about alternative uses for the money?

Develop new products?

Move into new markets?

 

[Texas Proud]

Yep, he kinda misses the point...

When you look at cost of capital, invested capital is very costly... for some reason shareholders want a return of between 8% to 12% (or even higher)...

OTOH, bondholders are happy with the 1.5% they get now...


You just have to balance the two so you do not get in a cash crunch if the economy goes down...

 

[Totoro]

You just have to balance the two so you do not get in a cash crunch if the economy goes down...

That's exactly it.

Borrowing money and then paying it out in dividends is equivalant to converting existing equity to debt ("levering up").

That's all fine and dandy as long as the return on capital is higher than the interest rate on the bonds, and indeed if the business can renew loans or pay the principal back when due as well under all circumstances (including a really serious depression).

In that case shareholders are getting a great deal: e.g. cost of capital 5% and return on capital 15% means for every borrowed dollar you "win" 10%.

If your business is volatile, sensitive to economic cycles or consumes more cash than it generates, trouble can come to town really fast though. After 2008 some companies learned some hard real life lessons there. Better err on the safe side.

As a general statement saying "it's nuts" is not really useful. Some companies also borrow because they have cash plenty overseas, but don't want to bring it "home" to postpone paying taxes for as long as possible.

Statement seems to be taken out of context it seems.Stan Druckenmiller is a very smart guy.

 

[Big_Hitter]

Statement seems to be taken out of context it seems.Stan Druckenmiller is a very smart guy.

no doubt - I'm sure he has a crap ton more $$$ than I do

 

[Fermion]

no doubt - I'm sure he has a crap ton more $$$ than I do

Meh, he is only about $4,448,500,000 richer than we are.