Share buyback w/ debt question

Discussion in 'Trading' started by dividend, Oct 9, 2007.

  1. What are the conditions under which a corporate stock buyback using debt makes sense? (Example: YUM $4 B buyback.) A cash buyback makes sense because there is no change in assets (cash = stock) while increasing EPS.
  2. There's no change in assets either if debt is used for a buyback. Debt is an asset. The only legitimate reason why a company might use debt for a buyback is if they feel the stock is underpriced and they want to "appease" shareholders. It generally also means that a company sees fewer growth opportunities in the near future. It's "riskier" for a company to also use debt to buy back stock. The risk of ownership is transferred from stockholders to debtors, so current debt holders wouldn't be too thrilled most likely.

  3. In theory it makes sense while it reduces the company's weighted average cost of capital. Beyond a certain point too much debt increases the WACC due to the increased risk to both shareholders and debt holders. Normally debt is cheaper than equity from the company point of view.

    Most companies remain under-leveraged due to agency factors (management likes to have a comfortable cushion) and this is the gap private equity exploits (usually).

    It can also be done cynically as a poison pill.

    Debt is not an asset, but the cash is and they of course balance - I think this is what he meant above.
  4. So when management thinks conditions are not as robust they begin to buyback with debt. Or it could be a poison pill tactic or just buying to appease shareholders.

    They could have used debt to finance growth in China or elsewhere; rather they chose to buyback stock. So I can conclude that management thinks that the return on stock sum tax benefit on debt interest will be higher than the return on growth operations.
  5. Yes, sorry, that is exactly what I meant. Assets=Liabilities+Owner's Equity.
  6. Yes, that is correct for the most part. It may also just be that at the *current* time they don't see great opportunities.

    Or that the company does'nt want to take any risks with projects, so they "appease" stockholders who are screaming for return for their investment.

    The other poster is correct to in identifying WACC. It could also be that their capital structure is out of line with their preferred mix of equities and debt, so they "realign" it.