Outlook: BG becomes a dedicated follower of fashion

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The Independent Online
Today's widely expected news from BG Group that it intends to buy back more than pounds 1bn of its shares presents this once troubled organisation with an intriguing public relations challenge. Having complained so loudly and bitterly about Clare Spottiswoode's new price controls, is Richard Giordano, the chairman, really proposing to turn round and say "only kidding. Actually we could have afforded a lot more"? This time last year he and his executives were claiming that the gas regulator's proposals amounted to theft, that they would destroy the company and endanger public safety. Now it appears that even after Ms Spottiswoode's savaging, the company still has the odd copper or two left to treat shareholders with. Talk about crying wolf.

On the face of, then, BG Group has quite a somersault to perform. The spectacle should make good sport. In the end, however, the potential for embarrassment here should not be allowed to get in the way of what may be a sound idea. Though a big share buy-back may seem a bit rich from the point of view of consumers (should this money not have been spent on yet further price reductions?), this is actually not the way to look at it. What BG is proposing is to rejig its capital by replacing equity with debt. It makes no difference to customers whether capital is in the form of debt or equity. It's not their money, so why should they care? If the cost of servicing the debt is cheaper than paying dividends, then over the long term it might actually be to their benefit.

Like most modern-day commercial trends, the present fashion for buy-backs comes from the US, where they are now commonly used as a substitute for dividends. Already we have seen quite a lot of it here too, of course, but on nothing like the same scale as the US. Furthermore, there is still resistance in the City to the idea that buy-backs should be used as a substitute for dividends. Where the US leads, however, Britain tends to follow. Fee-hungry investment bankers are pursuing the opportunities with a whole battery of corporate clients and it could well be that we are on the verge of a veritable explosion in these things.

In the US, the thinking behind them broadly goes like this. Stock yields are now so low that companies need to find other ways of rewarding their shareholders. One way is to pay them in capital. There are also tax advantages in doing it this way since dividends are paid out of a company's net profits while interest on debt is paid out of gross profits.

With the abolition in the last Budget of tax credits on dividends, some of the same factors are beginning to come into play in the UK too. Dividends are now worth 20 per cent less to the big pension funds than they were before the Budget. In these circumstances both corporate and government bonds are made that much more attractive.

There are other factors too driving the big pension funds away from equity and towards bonds. The requirements of an ageing population and new government-imposed "minimum funding requirements" are forcing the pensions industry progressively into the so called "safe" investment of debt. In other words, there is a real and possibly unsatisfied demand for bonds, while demand for equity may be on the wane. This is not to argue that the cult of equity is over, but it may not run as strongly as it did.

The buy-back is a logical consequence of these developments. In the UK, the tendency has been for companies to use cash or bank borrowings to fund these exercises, but it can only be a matter of time before the process finds its mirror imagine in a revival of the corporate bond market. What could be neater than to buy back unwanted equity, then soak up the capital once more with a corporate bond issue.

A good racket for the City, obviously. The tougher question is whether all this gearing up of the corporate balance sheet is entirely wise. In BG's case the balance sheet is plainly capable of taking much heavier debt gearing without causing undue concern. There are obvious dangers involved, however. It all looks fine at the moment with interest rates relatively low and inflation in abeyance, but what happens in the next recession?

Today's good idea may well seem like a rather bad one in the cold light of the next economic downturn. Investors are only prepared to provide a fixed interest rate for so long. In the event of a prolonged downturn, companies will be queuing up to go the other way and refinance their over- geared balance sheets with cheaper equity. For the time being, however, the fashion is for the plunging neckline and the City will welcome what BG is doing with open arms.

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