On dividends and share buybacks

Note: Today’s post is solely based on French references. For once.

As some of you may know by now, corporate finance is one of my ‘little weaknesses’ and I am always fond of press articles illustrating – with very variable success – simple corporate finance theories. Last Friday the French newspaper Les Echos involuntarily published two great articles on the use and impact of dividends and share buy-backs.

In a nutshell, the first article voiced the disappointment of TF1’s shareholders – TF1 is the largest private TV media group in France – as the dividend in 2015 was lower than in 2014 and the share buyback program of €30m was less sizeable than expected. One expert quoted in the article stated that “one could have expected more cash return to shareholders after the Eurosport disposal”.

Credits: Jantoo.com.
Credits: Jantoo.com.

And yet this is a common fallacy in which many shareholders fall. Higher dividends can be seen at best as neutral, but more often than not they are send a negative signal to the investor community. Why? Dividends are by definition money paid by the company to its shareholders. It is simply a transfer of wealth, not a value-creating mechanism, and as a consequence any dividend payment is reflected in the share price ‘at cost’ – i.e. if a share is worth $100 pre-dividend and it pays a dividend of $5, the post-dividend share price is $95. Therefore, any shareholder can decide himself of the dividend he would like to receive, by selling (if the dividend is perceived as too low) or buying (if the dividend is perceived as too high) an appropriate number of shares. Worse, a ‘forced’ dividend payment implicitly assumes that the company cannot do anything better with the money than giving it back to its shareholders. This is a gloomy conclusion, if we consider the fact that many Treasury Bills pay a negative interest rate and stock markets stumble around.

And this is why the second article offers a more balanced view on the benefits of share buybacks. In one hand, several experts interpret this as a positive sign if the company is able to maintain its margins in the future and benefits from a strong cash position. On the other hand, many others perceive this as “waste” and missed opportunities in a low interest rate environment. France is by no means isolated, as the chart below shows.

Quarterly Share Repurchases ($M) and Number of Companies Repurchasing Shares. Source: FactSet.
Quarterly Share Repurchases ($M) and Number of Companies Repurchasing Shares.
Source: FactSet.

To conclude, the fact that share buybacks are making a comeback is worrying sign for the state of the global economy. Companies are struggling to spot even barely profitable investments while shareholders are ready to claim their money with limited investment alternatives available. At a global level, all the money leaving the economic circuit is ultimately harming the recovery – through what economists call the multiplier effect, more on that in another post. This is no more, no less the vicious circle Joseph Stiglitz was also condemning in his latest Les Echos column. Shareholders must be careful about what they ask.

Updated: As I was finalising this article, I came across this article from today’s Financial Times which not only provides further quantitative evidence to the rise of dividends in 2015 but also jeopardises my promise to only quote French articles…

Twitter or swansong?

Twitter released last week its results for the financial year 2015. The event offered mixed news, the significant increase in revenues (from $1.4bn in FY14 to $2.2bn in FY2015) being offset by the stagnation of the monthly active user base to 320m over the last 2 quarters of the year.

By judging at the share price evolution over the next trading day, stock markets were clearly not expecting such an outcome. Share price dropped by as much as 14% before recovering and closing the day with a limited loss of 1.9% – although no new data had been released in the meantime.

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Black or white swan?

This behaviour illustrates the difficulty analysts and investors have to value many of the ‘2.0’ companies. LinkedIn learnt it the hard way, giving up half of its market capitalisation in one day after announcing its 2015 results a couple of weeks ago. Other companies such as Google, Facebook or Amazon also had their own fights against the stock market but now offer relative steadiness in an industry known for dramatic and disruptive change.

SP evolution
Indexed share price evolution of Twitter, LinkedIn, Facebook and Google compared with the S&P500 (index 100 as of January 2014). Source: CapitalIQ.

Twitter is even more of a ‘tough beast’ since, contrary to the three other companies listed above, it keeps bleeding cash. Lots of cash. As much as $580m in 2015. The situation is not hopeless though. In one hand, the company’s operating cash flow (i.e. the cash generated by ‘day-to-day’ activities) increased significantly, from $82m in 2014 to $383m in 2015. On the other hand, over the last couple of years, the company spent an average of $1bn per year in investing activities. Investors are now trying to assess whether Twitter’s survival goes through colossal investment needs and, if so, whether Twitter will be able to generate sufficient operating cash flows to offset these costs.

Part of the answer lies in the purpose and the business model of Twitter. Both of which are not very clear and distinctive. We use Facebook primarily to interact with friends, LinkedIn is our professional ‘shop window’, Google provides services making our life easier (including email). Conversely, the ‘raison d’etre’ of Twitter’s 140-sign messages is far from obvious – and the way to monetise them is even less so. By judging at the relative variance in analysts’ target share prices, this questioning seems widely shared.

Rebased distribution of analysts' target share prices as of 16/02 for Twitter, LinkedIn, Facebook and Google (100 = share price as of 15/02). Source: Author research.
Rebased distribution of analysts’ target share prices as of 16/02 for Twitter, LinkedIn, Facebook and Google (100 = share price as of 15/02).
Source: Author research.

Last but not least, the Twitter case also embodies the shortcomings of EBITDA as a meaningful financial aggregate. Despite the Enterprise Value / EBITDA ratio being widely used by investors, the EBITDA aggregate is in this case meaningless and even more when it is ‘adjusted’ as per Twitter accounts. Losing $580m of cash is indeed not incompatible with the fact of reporting a highly positive adjusted EBITDA – $558m to be precise. The main reason is that the large investments Twitter agrees to today are by definition capitalised and amortised and therefore accounted for in the ‘Depreciation & Amortisation’ line of the P&L (that is to say, below EBITDA). As written earlier, disregarding these investment needs when valuing the company would be careless.