Outlook: Dangers in the buyback craze
Thursday 15 January 1998
According to investment banks, 1998 is going to establish a new record for share buybacks and other forms of capital repayment. The reasons are well rehearsed. Companies are being required by their shareholders to "focus" on core capabilities, and the return on capital required of them is much more demanding than it was. As a result, many companies are beginning to throw off excess capital in large quantities. Furthermore, with present very low long term interest rates, the cost of capital can be significantly reduced by swapping equity for debt.
This in turn seems to suit the big investing institutions, who are beginning to view equities as excessively priced. As pension funds mature, their need, in any case, is to move away from "high risk" equities into "low risk" debt and bonds. How wonderfully convenient, then, that this is what the share buyback allows them to do.
Even assuming all this stacks up, and is not just some eloquent piece of theoretical nonsense dreamt up by clever investment bankers in order better to earn their fee, there are clear dangers in the process. All looks fine and dandy in today's benign environment of low inflation and continued growth, but what happens during the next business downturn? Many of these companies will be back, cap in hand, asking for expensive debt to be converted into low yielding equity. C'est la vie.
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