Lament for share buyback short-termism

Bolko Hohaus, who manages a technology fund for Lombard Odier in Geneva, recently called on the chief financial officer of a tech company in the US to try to understand why that firm had engaged in such aggressive share buybacks rather than in dividend payments to shareholders or in longer term research and development to support future growth.

"The man said to me, in this country we don't really have a social security system," he recalls. "We have to get rich quick."

Mr Hohaus is on a crusade against share buybacks that enrich management while doing little for minority shareholders. He is especially upset about the propensity of a group of tech companies in particular to grant options or stock units to executives and then buy back shares to offset that issuance.

That initial sin is compounded in many cases by opaque accounting or the extensive use of pro forma rather than generally accepted accounting principles (GAAP), which often conceal the extent of dilution for shareholders such as himself. And while management laments the lack of a long-term perspective among investors, Mr Hohaus laments the short-termism of executives who engage less in investment than in such financial engineering.

Mr Hohaus' campaign comes at a time when the role of buybacks in the US market generally has become an increasingly important factor and the debate about tech company practices and valuations has become more intense.

"If a company gives out a stash of options diluting shareholders by 10 per cent and then buys them all back, you could say nobody got harmed," he notes. "But the truth is that the money does not find its way back to shareholders but into the pockets of employees as a substitute for wages that would otherwise need to be expensed."

"Corporates in America are increasingly devouring themselves in a cannibalistic fashion as they opt to buy back more shares regardless of the price, rather than invest in the future," wrote Chris Woods of CLSA in a recent note to investors. "The data shows that S&P 500 share buybacks, combined with dividends, accounted for 95 per cent of reported earnings in 2014, with a record $104bn in February. Share buybacks are by far the most important driver of market direction."

Still, Mr Hohaus does not attack all tech companies indiscriminately, nor does he allege that all of them indulge in what he calls fake share buybacks. The first week in May for example, Apple announced it planned to raise $8bn in debt to help fund its fourth buyback driven deal in just over a year. Apple plans to spend $200bn mostly on buybacks (though some amount on dividends) through March of 2017. "The company has now launched $43.5bn of long term US dollar-denominated debt offerings since April 2013, backing massive capital returns to shareholders," the Leveraged Commentary & Data arm of Standard & Poor's noted. Apple has spent $80bn on such buybacks over the past two years, LCD added.

At least Apple has strong growth prospects so its earnings per share are not reliant solely on buybacks - unlike some of the other tech companies Mr Hohaus follows. The fund manager is especially down on tech companies that no longer have such promising growth prospects, including both Microsoft and Oracle.

Both companies have posted modest growth in operating income. But if you were to expense the money that employees including top management received via options and buybacks, for Microsoft, by way of example, non GAAP operating income was actually down, he says. And of course giving out share options and engaging in share buybacks helps to avoid the sort of margin squeeze that could come from simply paying executives more. Meanwhile, Oracle has spent almost $24bn on share buybacks in the past 10 quarters or 13.7 per cent of its average market cap during the period, while Microsoft has spent $21.2bn, or 6.7 per cent of its average market cap.

Other fund managers say some of the newer dotcoms are even more egregious in their accounting practices and the dramatic rise in stock compensation they offer their senior staffers. Moreover, often their pro forma earnings per share are far higher than their results under GAAP.

Currencies have always differed as a measure of store of value. In the case of many of these companies the same currency - the shares they issue - are clearly more valuable for their executives than for other shareholders.

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