COVID-19 – Let stock buybacks die

By David Nelson, CFA

COVID-19 has done more than bring the world economy to its knees. It’s forcing decisions about life and death beyond that of our neighbors and loved ones. The actions of government and now the Federal Reserve includes a rescue package $Trillions in scope whose current goal is to return the status quo.

History will judge whether current policy including the virtual shutdown of the economy was correct, but I’d like to focus on the conversation that follows. Crisis breeds its own destruction, but it can also be a catalyst for change.

That conversation is starting to show up in both print and broadcast media touching on corporate behavior I’ve spent a career opposing.

PalihapIn a recent on-air interview that went viral venture capitalist Chamath Palihapitiya told on air host CNBC’s Scott Wapner that we should let the airlines die. Jaws dropped as he was forced to repeat his statement, but It begs the question is he wrong?

I believe the goal of government is to ensure key industries and jobs are supported, not necessarily to protect equity and debt risk capital. Mr. Palihapitiya points out just because a company fails and enters a packaged bankruptcy the business often goes on with new owners.

That’s as it should be. Hard to defend management that wasted $Billions buying back their stock in a desperate effort to offset dilution from stock-based compensation.

All too often stock buybacks are used by CEOs who’ve run out of ideas on how to grow the company. What they’re really saying is; “I’m not risking my bonus.” It’s important to remember that a stock buyback does nothing for sales or earnings. It only increases earnings per share because the number of shares outstanding are reduced.

Every MASH doctor knows battle triage has to be performed to save those most likely to survive. If doctors treating the virus have to decide which of their patients get a ventilator, I would think our government should make the same choices handing out billion-dollar lifelines to miss-managed companies that would be better off in a packaged bankruptcy.

Airlines have bought back over $47 Billion in stock in the last 10 years

AAAmerican Airlines CEO Doug Parker doesn’t have the biggest of executive suite salaries. It pales in comparison to Discovery’s (DISCA) CEO David Zaslav who received $129 Million in 2018 but $11 Million in stock-based compensation is nothing to sneeze at. Mr. Parker has been at the helm since 2013 and decided since that time to take no salary but only stock-based compensation.

On the surface it looks like he is putting shareholders first, but you can bet he ended up making way more money getting paid in stock. That choice has let him pocket $70 plus million during his tenure. Few public companies could afford to pay such outsized salaries if forced to use cold hard cash.

Taking the helm in late 2013 following the merger of US Airways and American Mr. Parker oversaw the buyback of more than $12.9 Billion of the company’s shares while at the same time delivering negative ($5.6 Billion) in Free Cash Flow. Cash on the balance sheet has gone down almost every year from over $10 Billion to less than $4 Billion. Even if you use a cutoff date of December 31, 2019 before the coronavirus hit, shareholders made a six year total return of just 15% and of course today have been wiped out.

American Airlines (Use of Cash)
AA buyback
*FactSet data

If it looks like I’m picking on Doug Parker I’m not. He’s just tip of the iceberg. In the last 10 years 6 of the biggest airlines including Delta, United, Alaska, American, Southwest and JetBlue have shelled out over $47 Billion in stock buybacks. 

Barron’s recently reported more than $2 trillion in stock was repurchased by S&P 500 companies from 2017 through 2019. It’s true once COVID-19 started to unfold many companies announced they would halt the practice but just how long do you think it will take to turn the buyback machines on once the crisis has passed.

I first wrote about my objections to stock buybacks and stock based compensation in an article for Yahoo’s Tumblr back in 2015, Why CEOs make over 300 times more than workers. The passage below puts the origins in context.

Early in his presidency, Bill Clinton decided CEO’s were making too much money and concluded government should play a role in leveling the playing field. His solution was using IRS tax code 162 (m) which limits the deduction of CEO Pay as an expense to $1 Million. On its own that might have forced boards to reconsider high compensation as the lack of a write off would start to cut into profits and eventually share prices. However, the code permits expensing of “performance” based pay above the stated $1 Million if certain goals are met…

Clinton’s law soon became an inside joke in boardrooms across America. Performance based compensation much of which came in the form of stock options and restricted stock exploded in the 90’s during the run up into and bursting of the internet bubble. The recession that followed along with the financial crisis weighed on compensation, but the last 5 years has seen a return to trend with C suite pay rising far faster than the rest of the workforce.

Catalyst for Change

The only way to offset the dilution from all this stock issuance is to reduce the number of shares outstanding. To that end, public companies announce wave after wave of stock buyback programs. Twenty-five years later the gap between CEO and worker pay is the widest ever.

It’s hard to believe anything good can come out of the COVID-19 pandemic but perhaps it can also act as a catalyst for change. In the months and years ahead we can expect change in many aspects of our daily lives.

Every economic system has its failures. Stock buybacks and excessive CEO pay sit at the top of my list of things we can live without. If we need to amputate a hopelessly diseased appendage to corporate structure let it be buybacks. Tired phrases like efficient return of capital aren’t just self serving, they are BS.

Management should be paid the way the rest of the world gets paid, with a paycheck. I have no problem how big that paycheck is. I’m sure CEO expertise is worth at least that of a basketball player or an actor. When companies start paying CEOs in cash rather than stock the income inequality gap between workers and their boss will start to narrow and we will have made a down payment on repairing the strongest economic engine the world has ever known.