A year ago, I wrote about the worrying increase in leverage among America’s blue chips caused by share repurchases (“Hollowed-out blue chips are the next subprime”). Today I want to return to the subject, because the travails of General Electric are a reliable signal of the trouble ahead for the large corporate sector of the U.S. economy.
GE GE, +0.13% was one of Wall Street’s major share buyback operators between 2015 and 2017; it repurchased $40 billion of shares at prices between $20 and $32. The share price is now $8.60, so the company has liquidated between $23 billion and $29 billion of its shareholders’ money on this utterly futile activity alone. Since the highest net income recorded by the company during those years was $8.8 billion in 2016, with 2015 and 2017 recording a loss, it has managed to lose more on its share repurchases during those three years than it made in operations, by a substantial margin.
Even more important, GE has now left itself with minus $48 billion in tangible net worth at Sept. 30, with actual genuine tangible debt of close to $100 billion. As the new CEO Larry Culp told CNBC last Monday: “We have no higher priority right now than bringing those leverage levels down.” The following day, GE announced the sale of 15% of its oil services arm Baker Hughes, for a round $4 billion.
Of course, since that sale values Baker Hughes at $26 billion, and GE paid $32 billion for 62% of Baker Hughes as recently as last year, which looks to me like a valuation for the whole company of $52 billion, GE shareholders appears to have lost half the value of their investment in Baker Hughes in about 18 months.
As I have said several times, GE has been abominably managed since the odious “Neutron Jack” Welch took over in 1981; let us hope that Culp, who had a fine track record at Danaher, can turn it around.
The GE situation reminds me of another overvalued conglomerate, based in the railroad sector, that had been one of the bluest of blue chips and that slithered into bankruptcy over a period of about two years, via a series of divestitures at fire-sale prices, each of which appeared to have enabled the company to “turn the corner.” Its bankruptcy was unthinkable — until it happened, shaking market confidence for the next year, especially in the commercial paper market, and tipping off a considerable recession.
For those of you lucky enough not to have been around that far back (and even I only learned about in business school, a couple of years later), I am referring to the Penn Central Corporation, which bit the dust in 1970. That too, or rather its predecessor New York Central (the two behemoths merged in 1968), had benefited from a managerial wizard, Robert R. Young, whose reputation in the 1950s was almost as overblown as Welch’s. The one way in which GE differs from Penn Central is that it has announced its intention to exit the commercial paper market, so at least that market won’t be spooked if it goes after redeeming most of its outstandings.
Just as Penn Central’s bankruptcy revealed weaknesses in several other major U.S. companies, such as Lockheed, and shook business confidence for several years (President Nixon resorted to bullying the Fed into money printing to try to escape from the resulting recession) so it’s likely that GE, or some other titan of U.S. industry, will go unexpectedly bankrupt in the next year or so and spark off a similar stock market meltdown and period of general gloom.
AT&T T, +0.07% with $181 billion of debt and minus $128 billion of tangible net worth, most of it through overpriced acquisitions, is another potential Penn Central lookalike; again its bankruptcy is unthinkable but not by any means impossible.
Share-repurchase shenanigans are not however confined to the dinosaurs of yesteryear. A recent Financial Times article outlined how the five tech companies with the most cash (Apple AAPL, +0.11% Alphabet GOOG, +0.04%GOOGL, +0.14% Cisco CSCO, +0.40% Microsoft MSFT, +0.13% and OracleORCL, +0.12% ) have repurchased an astounding $115 billion of stock in the first three quarters of 2018. By contrast, the total capital spending of the five companies was only $42.6 billion during the same period. The story then congratulated investors for having done so well out of President Trump’s tax reform, which lowered the corporate tax rate, thus encouraging investment in the United States. With share repurchases in these companies being almost three times their actual investment, one must wonder how much actual U.S. economic growth they are expecting.
These share repurchases are misguided in so many ways. First, Apple, Alphabet and Microsoft are valued by the stock market at close to $1 trillion, levels no company has ever reached before (Cisco and Oracle, to be fair, have more reasonable valuations, under $200 billion.) If you ignore the current stock price, a company repurchasing its shares is simply giving away its cash and reducing its share count; it creates no value. If you don’t ignore the share price, share repurchases are highly pro-cyclical, pushing up share prices in a bull market and raising the possibility that the company will be short of cash in the next recession. For $1 trillion companies, share repurchases are almost certainly being done very close to the top.
Either way, the company is not “giving” anything to shareholders (especially not to small shareholders, who generally do not have the possibility of dealing directly with the company Treasurer repurchasing the shares.)
Most likely, the share price rise caused by the heavy repurchases will merely bring a new set of even more ignorant investors into the shares, attracted by their apparent “momentum.” That is what has happened to the shares of the FAANGs in 2018 (until the last month) — share repurchases have pushed up their prices and brought in more suckers who are unlikely to be long-term happy shareholders.