Friday, February 29, 2008

Do Dell Share BuyBacks Create Value for Shareholders?

Dell Inc (DELL-$20.50) said Thursday that its fourth-quarter profit dropped 6.4 percent, to $679 million or 31 cents per share, in the quarter ended February 1, 2007 (including several one-time expenses totaling 7 cents per share and gains of 4 cents per share).

Analysts surveyed by Thomson Financial had predicted a profit of 36 cents per share. A year ago, the No. 2 PC Maker earned $726 million, or 32 cents per share.

The weaker 4Q:08 was due to margins, owing to higher operating expenses (slower than-expected pace of headcount reductions) and a shift in product mix (higher-than expected sales of lower-margin U.S. consumer computers, slightly offset by greater shipments of higher-margin notebooks).

Sales rose 10.5 percent to $15.99 billion, but that was below the $16.27 billion that analysts had expected. Dell said that its strength in unit growth sales was offset by year/year decline in average selling prices and lower than-expected enterprise (server/storage) shipments, due to product transitions and cutbacks in U.S. business IT spending.

Stock Repurchase Program

Dell, which
resumed its stock-buy back program following the end of an internal accounting probe, said it spent $4 billion to buy back 179 million shares of common stock in the quarter, at an average price of $22.35 a share. This repurchase activity represented 8% of the outstanding stock at the time the quarter began, according to CFO Donald Carney.

And, in the 1Q:09, Carney said the Company expects to spend at least an additional $1 billion on stock buybacks.

Dell's share repurchase program was initially announced on February 20, 1996, and the program is authorized to purchase shares at an aggregate cost not to exceed $30.0 billion, in open-market purchases.

Does a share repurchase program matter?

"Simply stated,
ceteris paribus, buying back shares reduces the number of shares outstanding [dilution] and increases shareholders' stake in the future cash flows of the company, noted Dell's vice president of investor relations, Lynn Tyson, in a December 5, 2007, posting on the "Dellshares" blog.

"At the end of the day a company wants to generate a return on its capital that's in excess of what it costs the company to obtain that capital - that's how it creates value for its shareholders," Tyson said.

Texas-based Dell has reduced its outstanding share count by 15% in the last four years. By decreasing shares outstanding, ipso facto, buybacks are accretive to earnings.

This begs the question, however, are Dell stockholders best served when the company uses its available cash to buy back shares?

In the short-run, the market usually responds positively to announcements of buy backs because they offer a supposed belief, often called a signal, that management seems to believe that the stock is undervalued and is confident about a company's future—and, hence its share price.

A second positive signal is management's confidence about the Company’s financial health. The belief that the company doesn't need the cash to cover future commitments such as interest payments and capital expenditures.

Dell has historically generated cash in excess of the cash required to run the business, and has then used this cash from operations to buy back its stock.

Is funding buy backs with current assets the best use of cash from operations?

As of the end of fiscal 2004, Dell had cumulatively repurchased 1.1 billion shares for an aggregate cost of approximately $14 billion, or $12.72 a share. Given that Dell currently trades at $20.50 a share, these were capital monies that generated a positive return.

Digging through regulatory filings, the 10Q unearthed, however, that recent activity has not offered as favorable a return to shareholders. Illustrating, perchance, that
buy backs cannot prop-up the market’s skeptical response to poor long-term operational performance?

From October 2004 through December 2005, the Company repurchased 22.0 million shares at average purchases of $39.62 a share.

And, for the 4Q:06 ended February 3, 2006, Dell repurchased 66 million of its own shares at average purchases of $30.29 a share.

Ergo, aside from an artificial boost to share-net, a shareholder can reasonable ask of Dell management as to whether or not recent stock buying is the most efficient use of its own capital?

In most cases, buybacks [do] create value because they help improve tax efficiency and prevent managers from investing in the wrong assets or pursuing unwise acquisitions [think Sprint-Nextel meger or eBay/Skype deal].

[However], boards and executives [must] understand the difference between fundamental value creation through improved performance and the purely mechanical effects of a buyback program on EPS. ~ Richard Dobbs & Werner Rehm
McKinsey & Co. [September 20, 2005]

In other words, Dell shouldn't confuse the value created by returning cash to shareholders with the value created by actual operational improvements.

Editor David J Phillips does not hold a financial interest in Dell Inc. The 10Q Detective has a Full Disclosure Policy.


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Essay About Dell Computer Corporation said...

Very informative and helpful. I was searching for this information but there are very limited resources. Thank you for providing this information

Essays On Dell Computer Corp