Source: AT&T
Since its first fiscal quarter of 2012, telecom behemoth AT&T (T +0.62%) has returned nearly $27 billion to investors through its share repurchase program. And while investors should applaud companies for seeking to return cash to investors the company does not need for current operations or growth, it is prudent for companies to seek to return capital in the most efficient manner possible. It appears that AT&T isn't doing that.
Before we begin, let's discuss why shareholders desire share buybacks. Remember that stock is nothing more than proportional ownership of a company – and for investors, its claim on future profits. Therefore, investors want to invest in a company that is working toward growing profits. However, if you have a company that is buying back and retiring shares, each share becomes more valuable on a ceteris paribus basis. And if the company is increasing its bottom line, the buyback is even better for investors.
However, share buybacks can be a negative for long-term investors. There have been countless examples of companies trying to time their buybacks with the same negative result of investors. In 2007, when the market was sitting near then all-time highs, buybacks as a percentage of S&P market cap approached 5% with over 80% of the companies buying their stock back. Less than two years later during the nadir of the stock market –when they should have been purchasing -- those numbers dropped to 1.5% and 30% respectively. Which brings us to AT&T's first issue: overpaying for the stock.
Overpaying for its shares
AT&T's first problem is it's overpaying for shares. Over the last ten fiscal quarters, AT&T has netted nearly $27 billion in share buybacks -- $26.6 billion to be exact -- and has retired 729 million shares when comparing the weighted average shares outstanding during that period. Doing the math, AT&T is paying roughly $36.43 per share. During that period, AT&T has only traded at that figure or above nearly 16% of the time.
To be fair to management, if they feel the stock is undervalued and they have no better use of the cash they should buy the stock regardless of the price and probably have added costs with buying back large blocks of stock. In addition, with share buybacks the company can discontinue the program as it sees fit; once a dividend is established, cuts generally are a negative for investors. However, it isn't as if AT&T didn't have a better use of cash ...
The DirectTV purchase negates its share buyback program
AT&T chose to use equity (read: share issuance) to pay for the DirecTV (DTV +0.00%) merger rather than take on debt. The end result is AT&T issuing roughly 900 million shares; more than the full amount the company bought back during its share buyback program. Also of note is its use of equity: Its wireless competitor, Verizon, decided to go to the debt markets when it needed financing to buy its wireless business outright. Most businesses have taken advantage of historically low interest rates for financing.
Of course, it isn't as if AT&T investors aren't getting anything for this dilution. DirecTV gives the company a new business and the ability to bundle pay-TV to its Internet and telephone bundles – a revenue per user boosting move. In addition, the company states operational synergies will average $1.6 billion per year by year three and EPS is accretive within one year, although the company doesn't say how much in its news release.
However, companies that are sure about the value of a merger usually use cash or debt to take full advantage of these benefits. By offering DirecTV equity, this allows DirecTV shareholders to participate in any unexpected upside -- or downside -- in the deal.
And, again, with rates at historical lows, one has to wonder why the company didn't choose that route for financing, perhaps AT&T's management doesn't feel their shares are undervalued -- that's another reason to use your equity to acquire another company.
Final thoughts
AT&T appears to have changed its strategy to enrich shareholders midstream. Last year, the company was focused on returning value by share repurchases – this year, growth by acquisition. Anytime a company changes its strategy, especially if it negates the last year plus, investors should pay keen attention to its new moves.
AT&T's shareholders should watch its DirecTV acquisition closely. As far as the buyback is concerned, the company should have held onto the cash if it had an acquisition in mind, and investors should ask why the company continues to repurchase shares after announcing this dilutive deal.
