eBay's (EBAY +1.49%) various businesses are growing quite nicely at the moment, but I'm surprisingly disappointed with the company nonetheless. Recently, it has become very obvious that investor capital is flowing into the pockets of insiders. C'mon eBay, it's not 1999 anymore.
Not all buybacks are created equal
The company reported in its second quarter earnings release that it has repurchased approximately $466 million of its common stock during the second quarter of 2013. That might not necessarily be a bad thing. We at The Motley Fool actually applaud properly executed stock repurchases, as they can create immense amounts of value for shareholders.
Loews is one such company that consistently creates value by repurchasing its shares on the open market at attractive prices. White Mountains Insurance is yet another company that consistently buys -- when it has excess capital -- its own shares when they trade at a discount. And Berkshire Hathaway's Warren Buffett recently announced his own intention to repurchase meaningful amounts of stock when it trades below 1.2 times book value.
Investors need to know, however, that not all buybacks are created equal. So I decided to take a closer look at eBay's repurchase behavior over the past few years.
The repurchase riddle
Over the past 12 quarters, going back to Q3 2010, eBay has bought back $3.6 billion worth of stock. The stock has approximately doubled over that time frame, so you might be thinking that was a great use of capital. Unfortunately, the diluted share count only decreased by 1% over those 12 quarters. The count went from 1.328 billion shares to 1.313 billion at the end of the recent quarter.
How can a company buy back $3.6 billion of stock and only reduce its share count by 15 million shares? That would imply a cost of $241 per share on average. We know the stock price was in the range of roughly $25 to $50 per share during that time.
The answer is that eBay issues a lot of stock to its employees. During the second quarter, their reported free cash flow was $658 million and they used 70% ($466 million) of it to repurchase shares. In Note 15 of their annual report, management clearly discloses the goal of their share repurchase program: "These stock repurchase programs are intended to offset the impact of dilution from our equity compensation programs."
As an investor in eBay, I'm not pleased with this. Here are my three recommendations for eBay's management team:
- Stop acting like a tech start-up. You've got over $11 billion of cash on your balance sheet. Pay people what they deserve in cash and let them purchase stock on the open market alongside the rest of us who decide to put our capital at risk.
- Treat stock repurchases like any other investment. Be strategic with your share repurchases, and you'll actually create value. I found a copy of The Outsiders by William Thorndike listed on eBay for only $17.18. This would make an excellent gift for the management team and board of directors. Buying back stock at regular intervals regardless of the price is a recipe for value destruction. Your stock hit a low during 2009 and there were zero repurchases. As the stock climbed from $10 to over $50 per share, repurchases have increased dramatically.
- Align the interests of owners and employees. This is quite simple at companies like Berkshire Hathaway, where the largest owner is also the operator of the business. Real owners put their hard-earned capital at risk when they purchase stock on the open market. eBay investors, for example, suffered in 2009 when the stock dropped to around $10 per share. Eligible employees, on the other hand, benefited from a stock option exchange program where underwater options could be exchanged for restricted stock.
Truly great businesses have management teams that are able to balance the needs of employees with those of outside investors. Issuing stock to employees at low prices, and then using shareholder capital to repurchase those same shares at higher rates isn't a recipe for outstanding returns over the long term. Surely, eBay can do better.
