Kudos to the New York Times’ Floyd Norris for this little bombshell:
On March 18, when the company reported a profit for the first quarter, even as other firms were reporting losses — and just after Bear Stearns collapsed — Lehman had to confront rumors that had sent its share price tumbling. It did so with pride and confidence. Erin M. Callan, the relatively new chief financial officer, now deposed, spoke of “disciplined liquidity and capital management, which we consider to be a core competency.”
With hindsight, it is clear that it is specifically in the area of capital management that Lehman has done the worst job, notwithstanding the boasts. Its policy on share buybacks was to avoid the dilution caused by grants of restricted shares and options issued to employees, and that meant it bought back about as many shares as it issued.
It succeeded. The number of shares outstanding at the end of the first quarter was virtually the same as it was at the end of the 2004 fiscal year, after adjusting for a stock split. But with the stock rising for much of that time, those purchases cost a lot of money. In the 13 quarters from the end of that year through this year’s first quarter — that is, before the new $2.8 billion loss — Lehman reported net income of $11.9 billion, and spent $11.8 billion on share repurchases.
The net effect was that Lehman built up no cushion during the good times, and was ill-prepared for the bad times. The hubris reflected in the claim that it could “deliver strong results in all market environments” left it with an insufficient capital cushion when the market environment turned hostile…..
Even if we assume that the company will get the higher conversion price [on its newly-issued convertible preferred], Lehman will have reaped $6 billion by issuing 203.4 million shares. That does not compare favorably with its share buybacks over the past 13 quarters, when it spent nearly twice as much to buy 189.5 million shares. It paid an average price of $62.19 for shares that dropped under $23 after the shake-up was announced.
Back in the early 1990s, when Sallie Krawchek was an analyst at Sanford Bernstein covering Wall Street, she observed that it was better to be an employee of an investment bank than a shareholder. That if anything has become more true over time.
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Much as I regard Cramer as a friend, one place where we disagreed the most was over buybacks. As in my last post here over Lehman, he regarded buybacks as a sign of confidence, in order to beat the shorts.
My view is that investment banks are like long-tail property-casualty insurers — you can’t really tell what the true profitability is each quarter. No one can. The best you can hope for is that the management is conservative, and releases profits slowly. Culturally, that is a tall order for Wall Street.
Regular buybacks are appropriate for companies with smooth earnings. Companies with lumpy earnings must satisfy themselves with occasional buybacks, when their stock is out-of-favor.
The 2007 IB bonuses about equalled the Q4 thru
Q1 2008 capital raising, from SWF’s and others. It was
argued 6 months ago that they “borrowed their bonuses”. I see no reason to disagree.
Are there any studies out there that can prove the effectiveness of buybacks? It seems to me that most of these companies tend to buy back stock at the top or close to the top and when their stock is out of favor, they don’t have the funds and end the programs.