RBS Share Buy-Back

The Royal Bank of Scotland (RBS) is proposing to buy-back up to 4.99% of its shares from the stake held by the Government (by UKFI on its behalf). At present the Government holds 62% of the company stemming from the bailout in the banking crisis ten years ago. They have been trying to get shot of it ever since as no Tory government thinks it should be investing in banks. This latest proposal makes it clear that UKFI cannot easily sell the shares in the market, nor place them with institutions, perhaps because there are still outstanding lawsuits faced by the company.

Should shareholders support this proposal? I don’t think so, and I will be voting against it with the few shares I hold which were acquired to support the ShareSoc campaign for the appointment of a Shareholder Committee. Incidentally this proposal rather suggests that it is now even more important to have such a Committee because this proposal may be of advantage to the Government but it is not at all clear whether it is of benefit to shareholders as a whole.

Fortunately UKFI won’t be able to vote their shares at the EGM to approve the proposed buy-back so other shareholders will decide the issue.

Other shareholders might wish to ask themselves, why should shares only be bought back from UKFI and not all shareholders, e.g. via a tender offer. Another negative is that this share buy-back is effectively a reduction in capital when banks like RBS still have a relatively thin equity capital base. In any case, I generally vote against buy-backs other than in investment trusts. They are usually misconceived. The Government commissioned research into share buy-backs a year ago on the grounds that they may be being used to inflate executive pay (reducing the number of shares in issue increases earnings per share which is a common element in executive pay bonus and LTIP schemes). The research has yet to produce a report.

Personally I would like to see share buy-backs made illegal except in very limited circumstances, as they used to be. They are rarely of benefit to other shareholders and can be used by foolish management to try to manage the share price.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Government To Review Share Buy-Backs

The BEIS Department of the Government has announced a review of share buy-backs. That’s where the company buys its own shares in the market, a practice that used to be illegal but is now very widespread.

Business Secretary Greg Clark said: “…there are concerns that some companies may be trying to artificially inflate executive pay by buying back their own shares. This review will examine how share buyback schemes are used and whether any action is required to prevent them from being abused.”

If a company buys back its shares, then it will increase the earnings per shares (EPS) because the same profits will be spread over fewer shares. But EPS is often an element in the calculation of performance related bonuses, e.g. in LTIPs. So effectively management can earn bonuses by simply deciding to buy back shares rather than really improving the underlying performance of the business.

Obviously cash has to be used to buy back the shares, and another concern is that this is money that should be used to develop new products, services or markets. In other words, it contributes to the lack of investment in the UK economy. In extremis companies can borrow money (i.e. gear up) to provide the funds to cover the buy-back which increases the risk profile of the company.

There is also the suspicion that some companies undertake large scale buy-backs to support their share price, often encouraged by institutional investors who wish to exit. The directors always deny this, but one can see the sub-conscious motive to “clear-up a share over-hang” that may be present. In practice, share buy-backs may benefit shareholders who are departing more than they benefit shareholders who remain.

In theory, if a company cannot find a good use for surplus cash, i.e. cannot reinvest it in the business profitably, then buying in shares where the per share intrinsic value of the company is more than the market share price should make sense. But determining what is the “intrinsic value” is not at all easy.

There are also tax issues to consider. Some investors think it’s best to retain the cash in the business because paying it out in dividends might incur more tax, and sooner, than the capital value growth that might otherwise be obtained.

You can see there are many complex issues around this topic that could fill a book, or at least a pamphlet. But here are some comments on the approach I take:

  1. I always vote against share buy-backs unless there are very good justifications given by management (and that’s about 1 in 20 votes in practice).
  2. The only general exception I make is investment companies (e.g. investment trusts) where it does make logical sense and can be used to control wide discounts.
  3. I prefer management to reinvest in growing the business if they have surplus cash (and as I rarely invest in no-growth businesses, you can see why the above rules are easy to apply).

If the advisors to the Government determine that share buy-backs are being undertaken for the wrong motives, what could they advise the BEIS to do about it? Reading the minds of directors about their motives for share buy-backs will not be very practical. If they simply wish to stop the abuses related to incentive schemes they could insist that all such schemes (including all share options) should be adjusted for the buy-back – they often are not at present. But would it not be simpler just to revert to the old regime and outlaw them except for investment companies? I do not recall it created any major practical problems.

If a company’s shares consistently trade below “intrinsic value” then someone will buy them sooner or later – after all many people believe in the perfect market hypothesis and it’s probably true to a large extent – particularly with large cap companies where share buy-backs are the most common. So simply banning share buy-backs should not create significant problems.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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