Commbank buys back $ 6 Billion dollars of its own shares: A waste of money?
On 11th August Commonwealth Bank (CBA.AX) announced that it will be purchasing $6 billion dollars’ worth of shares in a buy-back. This comes after a strong rally in the companies’ share price, having gone up around 47% over the past year. I believe this decision is a poor use of capital as repurchasing the shares after such a strong rally in share price may leave the company overpaying for these shares.
What is a buy-back?
A buy-back is when the company purchases it shares from existing shareholders. The shares are usually extinguished. This means that the total number of shares in the company are reduced and the value of the existing shares increases.
For example, let’s say there are 100 shares in a company. This means that each share is a 1% stake in the company. The company then proceeds to buys back 10 shares. Now there are 90 shares remaining in the company. So, each individual share is now worth 1.11% of the company.
The benefits of a buy-back
A buy-back benefits the shareholders. The shareholders have their stake in the company increased as the total number of shares is reduced but they retain the same number of shares. Therefore, the value of each share goes up. In the above example, if each share was initially worth $1, it should now be worth $1.11.
Why I disagree with Commbank’s decision to buy back shares
When a company has an excess sum of money, it has primarily 3 choices of what to do with that money. They are:
a. Pay shareholders dividends: This would give the money directly to the shareholders.
b. Conduct a buy-back
c. Invest the money back in the company: This would allow the company to grow and be more valuable by attracting talent, opening new locations etc.
The job of the management of a company is to choose the best possible option for the shareholders.
I argue that a buy-back is best done when the share price of a company is, in the opinion of management, undervalued. That is, if the company believes that the value of the company’s shares are $70 and the company is selling for $50, a buy-back would be a good choice as each purchase is creating $20 value for the existing shareholders. Conversely, if those same shares are trading at $100 then a buy-back is a terrible idea, as each share is purchased is losing the shareholders $30 in value.
Now, I can’t say that I can provide an accurate estimate of the fair value of the shares of a company, but I would rather a company purchase shares when the shares are trading at a discount and not a premium.
For example, let’s look at when AMD chose to announce the buy-back of 4 billion dollars of its own shares. The shares were trading at a significant discount to where they had recently been. In the past few months the shares were trading above $96 and when the buy-back was announced they were trading around $74.
Compare this to when Commbank announced its buy-back. The shares were trading near all time highs by quite a margin.
Given that Commbank shares were trading at such high prices, I believe that spending $ 6 billion dollars on a buy-back is a wasted opportunity as it is likely that Commbank is overpaying for these shares. The money spent could be utilised in better ways, for example, a dividend payment or reinvesting it into the business.
In Defence of Commbank
To be fair, the method via which Commbank is repurchasing these shares is quite smart. They are offering to buy the shares at a discount of 10-14% of the market price. To make this attractive to shareholders, any payment over $21.66 per share will be considered a fully franked dividend. This may have significant tax implications and reduce the tax payable by shareholders.
Conclusion
I believe that Commbank’s decision to buy-back $ 6 billion dollars’ worth of shares is a poor use of capital, given where it’s share price is at. However, this concern is somewhat ameliorated by the format of the buy-back, with the shares being sold at a discount to the current price.
It is true that shareholders will benefit from this buy-back. Their shareholding will go up in Commbank without them doing anything, increasing earnings per share and future dividends, as highlighted by the board.
However, a fundamental axiom of investing is to buy low and sell high. In my opinion, Commbank is going against this tenant by buying when the price is high making this an inefficient use of its capital. Management should only conduct a buy-back when shares are trading at below their fair value.
In my opinion if this same buy-back was conducted at a different point in time when the share price was lower, it would have been a better use of capital. As it currently stands, I would rather a special dividend payment be paid to shareholders or the money reinvested in the business.
