Last Thursday, September 4, 2014, luxury goods retailer Nordstrom, (NYSE:JWN) announced that its board of directors had authorized a $1 billion share repurchase program. This goes on top of the $323 million remaining on its current buyback authorization. According to the press release, Nordstrom plans to fund the repurchase with "existing cash on hand."

Nordstrom's board just approved a new $1 billion share repurchase (Photo: The Motley Fool)

There's just one problem. Nordstrom doesn't have $1 billion (let alone $1.323 billion) in existing cash on hand! As of early August, Nordstrom had $772 million in cash and cash equivalents in its bank account. What the heck is the company doing?

The big buyback caveat
One thing that investors should keep in mind with regard to share repurchase plans is that they are never set in stone. While Nordstrom's board has "authorized" a $1 billion buyback, that does not mean that the company is bound to follow through. The management team almost always has discretion on how, when, and if it should buy back shares.

This means that decisions to "authorize" a share repurchase are sometimes more about making a symbolic gesture than anything else. A company can announce share repurchase plans in order to get investors excited about the stock, and then fail to complete the advertised buyback.

Nordstrom's goal
Nordstrom executives probably aren't acting quite so cynically. However, to understand why Nordstrom is announcing a big buyback plan, it is necessary to look at another recent event: Nordstrom's acquisition of Trunk Club, first announced in late July.

Trunk Club sells men's clothing through personal stylists who meet with potential clients and select merchandise to ship to them. Customers can then choose what they like and return the rest for free. Nordstrom executives believe that Trunk Club's personalized service fits well with the company's strengths and that the acquisition will help Nordstrom connect better with certain customers.

In the long run, Trunk Club seems like a potentially valuable addition to Nordstrom's business. However, Nordstrom warned investors that the acquisition will reduce EPS by 3%-5% this year and will continue to be dilutive to earnings for the next several years. A major reason for this EPS impact is that the purchase price of $350 million is being paid in Nordstrom stock.

This payment structure gives Trunk Club's management a stake in Nordstrom's future financial performance. On the flip side, existing Nordstrom shareholders now own a smaller percentage of the company. A $1 billion share repurchase would more than offset this "dilution", while sending a strong signal to investors that Nordstrom will return excess cash to them over time.

Where's the money?
Even if Nordstrom really does intend to buy back $1 billion of stock, there is still the question of how it will pay the bill. The share repurchase authorization expires in March, 2016, so Nordstrom has just 18 months to find more than $1.3 billion (including the amount remaining on the prior authorization).

Nordstrom's free cash flow is strong despite its growth investments (Photo: The Motley Fool)

Nordstrom has less than $800 million in cash on hand, but it does generate plenty of free cash flow. Last year, free cash flow was approximately $500 million. Since retailers' free cash flow is heavily weighted toward the second half of the year, Nordstrom may generate $1 billion in free cash flow between now and March, 2016 despite investing heavily to drive future growth.

This alone may be sufficient to fund Nordstrom's buyback plans while still leaving a reasonable cash cushion. Given the low interest rate environment, Nordstrom could also follow the example of many other public companies by issuing some debt in order to buy back shares.

Lastly, Nordstrom may raise a significant amount of cash by selling its credit card receivables. Nordstrom is one of the few U.S. retailers that still operates its own bank to issue credit cards. However, the company recently announced that it is exploring the possibility of selling its credit card business to a traditional financial institution.

As of last month, Nordstrom's credit card receivables (the amounts owed to Nordstrom by credit card customers) totaled more than $2.3 billion. Many banks have shown a willingness to pay at least book value for these accounts. Nordstrom could thus generate a substantial sum of cash if it decides to go ahead and sell its credit card receivables.

Foolish bottom line
Nordstrom's assertion that it will buy back $1 billion of stock within the next 18 months using existing cash on hand is clearly false: the company does not have $1 billion in cash on hand. That said, this doesn't seem like a situation where the company is just posturing and does not plan to follow through on the buyback announcement.

Nordstrom's free cash flow between now and March, 2016 should cover most of the buyback's cost. Nordstrom could also draw down its cash on hand to fund share repurchases. Nordstrom may issue debt or sell its credit card receivables to fund additional buybacks.

The first $350 million of the new repurchase program will effectively go toward offsetting the dilution caused by the recent acquisition of Trunk Club. However, if Nordstrom completes the full buyback, it will significantly reduce the number of outstanding shares, creating value for long-term shareholders.

Adam Levine-Weinberg owns shares of Nordstrom. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.