This Is One of the Most Misleading Terms in Finance

As buyback activity ramps up on Wall Street, many major companies are turning to accelerated share repurchase agreements with major investment banks. Most notably, Apple (NASDAQ: AAPL  ) CEO Tim Cook told The Wall Street Journal earlier this month that the company had just spent $14 billion to buy back stock. Of that amount, $12 billion went into an accelerated share repurchase program.

Apple recently began a new accelerated share repurchase program.

Many investors believe -- incorrectly -- that an accelerated share repurchase involves Apple buying back stock very quickly! Cook furthered that misperception by stating that Apple moved aggressively to buy back shares to take advantage of a big decline in Apple's stock price.

However, "accelerated share repurchase" is actually a very misleading term. In fact, for companies looking to capitalize on short-term stock price drops, accelerated share repurchases aren't especially useful.

What is an accelerated share repurchase?
So what is an accelerated share repurchase, anyway? Essentially, it is a bulk agreement between a company and one or more investment banks, in which the investment banks serve as agents for buying the stock.

Typically, the company makes an upfront cash payment to the investment banks and receives a portion of the shares that it could buy back with that money. The investment banks borrow those shares either from client accounts or on the open market. This is the "accelerated" part of the repurchase.

Then, the investment banks' traders buy the company's stock over a period that can extend for several months, up to the amount of the cash payment they received (minus a premium for their work). These shares are first used to replace the shares they borrowed, and the rest are delivered to the company at the end of the repurchase period.

The number of shares that the client -- in this case, Apple -- receives is usually determined by the volume-weighted average trading price of the stock over the term of the accelerated share repurchase agreement. Thus, if the stock price rises during the term of the share repurchase agreement, the company would end up receiving fewer shares of its stock.

Slow "accelerated" share repurchases
Apple's recently announced share repurchase program is its third in the past two years. Its two previous programs show just how slow an "accelerated share repurchase" can be. Apple entered into an accelerated share repurchase agreement to repurchase $1.95 billion of stock in August 2012. Final settlement of this agreement did not occur until April 2013.

Apple then started a $12 billion accelerated share repurchase agreement last April. As of a few weeks ago, that accelerated share repurchase had not yet been completed. This suggests that Apple's new agreement -- which also calls for $12 billion of stock buybacks -- could take close to a year to be completed.

Not exactly opportunistic
Since the final price per share in an accelerated share repurchase is determined by the stock's average trading price over a period of many months, it's not a good tool for a company looking to time the market. In terms of the total time to completion, accelerated share repurchases tend to be much slower than open market purchases!

Apple executives may have thought that their stock looked cheap when it fell to $500 after its last earnings report. However, within a few weeks, Apple stock had bounced back to roughly the same range where it was trading before earnings. If the stock continues moving higher, Apple will end up paying significantly more than $500 a share in this accelerated share repurchase.

AAPL Chart

Apple 3 Month Stock Chart, data by YCharts

Similarly, Apple began its last $12 billion accelerated share repurchase when the stock had plummeted to just over $400 in April 2013. However, the stock made a big comeback in the second half of 2013, which will probably drive the average purchase price for that program closer to $500.

Foolish bottom line
When investors hear the term "accelerated share repurchase," they usually assume -- quite reasonably -- that it means buying back stock very quickly. However, the term is misleading. From a shareholder perspective, an accelerated share repurchase is quite slow, since the final price is determined by the average price of the stock over a period of many months.

In the case of Apple's recent buyback, it means the company won't get its shares at an especially favorable price. On the other hand, it also means that pundits who have accused Apple of manipulating the stock market are misguided (most of the shares to be repurchased won't be bought until months from now). The success or failure of the buyback will depend solely on whether Apple is able to drive organic earnings growth over time.

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  • Report this Comment On February 22, 2014, at 1:40 PM, WineHouse wrote:

    Thank you for this careful explanation! It does seem to "show up" the so-called experts who write articles. Unfortunately, gullibility is enhanced by ignorance.

  • Report this Comment On February 22, 2014, at 10:42 PM, SimchaStein wrote:

    When I look at Yahoo finance and the updated Shares outstanding, am I to assume the more shares will be repurchased (of the $14B ASP) ? If so that means higher earnings per share; and more competition for stock. Both should drive the stock price up.

  • Report this Comment On February 23, 2014, at 9:15 AM, TMFGemHunter wrote:

    The Yahoo Finance figures will be as of the end of December. So there will be fewer shares outstanding at the end of next month. That will give a modest boost to EPS which may not be fully reflected in analysts' estimates. I don't think it really creates more competition for Apple stock. It's a pretty small drop in the bucket.

    Adam

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