Does This Buyback Plan Make Any Sense?

OLED expert Universal Display (NASDAQ: OLED  ) hasn't been kind to its shareholders lately. Share prices have plunged 25% since the company reported disappointing third-quarter results, and the stock is down 58% from the 52-week highs of $55 per share.

The company's board of directors saw these negative price trends and decided it was time to take advantage of the soft market. Universal Display just announced a $50 million share buyback program, which at current prices would take about 5% of its shares off the market.

"This stock repurchase program demonstrates the confidence that our board and management team have in the prospects and growth potential of the company," said CEO Steve Abramson. The buybacks will be funded from Universal's working capital reserves.

And that's where I raise a skeptical eyebrow. As a Universal shareholder myself, I'd prefer that the company would hold off on buybacks until it can afford to do it with free cash flow money. And that's not the case at all:

PANL Free Cash Flow TTM data by YCharts

Positive cash flows are a pretty new experience for this small cap. You see that generous cash balance, from which management intends to fund the buyback? Yeah, that's what remains of the $250 million secondary offering the company did in 2010. The buyback isn't so much about rewarding shareholders, but more like a paying down bits of a very large loan.

You could, of course, take the program at face value. What if Abramson and company see $50 million of free cash coming in over the next year or so? That would be a drastic jump from the current $13 million run rate. In that case, share prices will surely soar as the fresh cash is unveilled -- making later buybacks a pretty inefficient alternative.

But nobody is promising anything here. And maybe you missed this, but company leaders actually waste more shareholder value than they create in the average buyback.

Fellow Fool Morgan Housel pointed out that even financial masters like JPMorgan Chase (NYSE: JPM  ) tend to roast their capital in the open market. Closer to home for yours truly, Netflix (NASDAQ: NFLX  ) famously bought back a ton of shares at high prices only to sell them back again at a much lower valuation. This is the polar opposite of "buy low, sell high."

Will Universal Display bungle this buyback, too? Only time will tell. I agree that the stock looks cheap nowadays, but the company could certainly find better ways to put its cash to work.

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Comments from our Foolish Readers

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  • Report this Comment On November 14, 2012, at 5:43 PM, TMFSymington wrote:

    Ah! Your article beat my blog post to the punch, but it's interesting I'm taking the opposite stance on this one: http://beta.fool.com/symie5/2012/11/14/buyback-bad-idea/1655...

    Nonetheless, that's why they put the "Motley" in The Motley fool, right? I appreciate your thoughts as always, Mr. Bylund.

  • Report this Comment On November 15, 2012, at 2:08 AM, sidneyleejohnson wrote:

    I'll have to side with Steve on this..he elaborates more specifically what the secondary was for and the fact it left significant $ left over... but most importantly is the fact that most people can't explain how an IP/R&D firm like panl is suddenly going to be able to employ efficiently and appropriately large amounts of excess cash to expand its business internally through new hires of a very small pool of global chemistry talent. If there are no acquisitions of patents or other firms then a buy back makes complete sense. The idea that they can just scale their r&d investments internally with input from the extra cash is folly. There is simply not enough oled related talent available in the world for UDC to just rain the extra cash upon... so give it back to shareholders by buying it back at significantly lower than what you sold it for.. Brilliant.

  • Report this Comment On November 15, 2012, at 2:29 AM, sidneyleejohnson wrote:

    One last comment, I would really like to see the study on the impact of buybacks when the Institutional ownership >100% of the float. If UDC for example were able to buy back shares directly from Fidelity and Vanguard the largest sources of Securities Lending BY FAR what impact would it have on the gigantic short position on UDC? It would be the mother of all short squeezes as F&V would issue recalls and the shorts would have no where to cover from...

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