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SLA share purchases

Practical discussions about equity High-Yield Portfolios (HYP) for income
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tjh290633
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Re: SLA share purchases

#202256

Postby tjh290633 » February 19th, 2019, 9:36 am

I'm afraid that I am on Pyad's side in this. The only equitable way is to return cash to the shareholders and reduce the number of shares by a capital reorganisation. Better in my view is the tender process where shareholders are invited to tender their shares to the company for repurchase, if they wish. That way the number of shares is reduced, but the shareholders are under no compulsion to give up shares, nor need they reinvest the cash received to maintain their holding, costing them fees and stamp duty to boot.

Just buying back shares mainly benefits directors and their bonus plans.

TJH

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Re: SLA share purchases

#202684

Postby GoSeigen » February 20th, 2019, 5:23 pm

NeilW wrote:
pyad wrote: What they should say, but are cowards, is that they have returned money to certain shareholders.


It seems to me that they return company money to people who no longer want to be invested in the company. Why not return the money to those that wish to remain invested?


They do. You just don't understand how. Read my earlier posts and Gengulphus's.

GS

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Re: SLA share purchases

#202689

Postby GoSeigen » February 20th, 2019, 5:33 pm

Dod101 wrote:Sadly, at least in my opinion, pyad does readers no favours by expressing the views he does and by the way he expresses them. Share buybacks are used for a variety of reasons and I think that they are an efficient way for a company to reduce its capital base. The whole point of the sale by SLA of Standard Life's life insurance business to Phoenix Holdings was to become a 'capital light' investment manager. Share buybacks are an efficient way of reducing the capital in the business by reducing the number of shares in the market, in a very straightforward way. If they were to reduce the cash in the business (not quite the same thing) by paying a special dividend they would still have the problem of reducing the number of shares in the marketplace, and in any case, as has been said, they need to have the distributable reserves before they can pay a special dividend. Dividends ought only to be paid as a result of trading not reconstruction of capital.

The other thing about share buybacks is that they will usually help the continuing shareholders a) by reducing the number of mouths to be fed from future dividends, and (b), if they are bought at a price less than the book value, will probably help the share price. They also as a result of (a) increase modestly the economic interest of all continuing shareholders.

There are many and varied reasons for a company to buyback its shares and I am not particularly defending SLA. I do not hold them and have no interest in doing so. I think the best that can be said of SLA at the moment is that Sir Douglas Flint is the newly appointed non exec chairman. He might have so influence in improving the governance.

Dod


Most of this is spot on, but share buybacks do NOT reduce a company's capital. They have to be funded from distributable reserves.

GS

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Re: SLA share purchases

#202717

Postby TheMotorcycleBoy » February 20th, 2019, 7:29 pm

Surely when a firm issues stock in the first place it is just saying "I want to borrow some money, potentially for the very long term, and to reward you for your £££ you can effectively own a portion of me, and thus have a part to play in firms management".

When a firm buys back it's stock, either with profit or debt from a bank, it's just saying "Here's that money back that I borrowed from you earlier".

Simplistic perhaps, but when the firm became incorporated, I suppose, it could have acquired *more* initial capital from a traditional lender (bank). In fact, is not a primary reason for the prevalence of stock buybacks in the current times, in part, an artefact of mega low interest rates?

Matt

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Re: SLA share purchases

#202743

Postby tjh290633 » February 20th, 2019, 8:46 pm

TheMotorcycleBoy wrote:Surely when a firm issues stock in the first place it is just saying "I want to borrow some money, potentially for the very long term, and to reward you for your £££ you can effectively own a portion of me, and thus have a part to play in firms management".

When a firm buys back it's stock, either with profit or debt from a bank, it's just saying "Here's that money back that I borrowed from you earlier".

Simplistic perhaps, but when the firm became incorporated, I suppose, it could have acquired *more* initial capital from a traditional lender (bank). In fact, is not a primary reason for the prevalence of stock buybacks in the current times, in part, an artefact of mega low interest rates?

Matt

No, it's an artifact of directors' incentive schemes.

TJH

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Re: SLA share purchases

#202751

Postby Dod101 » February 20th, 2019, 9:49 pm

GoSeigen wrote:
share buybacks do NOT reduce a company's capital. They have to be funded from distributable reserves.

GS


Ok share buybacks may not reduce a company's share capital per se, but they do take shares out of the marketplace. They can either then be cancelled or place in treasury and in either case they are effectively reducing the share capital certainly on which dividends are paid; one of my main points.

Dod

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Re: SLA share purchases

#202796

Postby TheMotorcycleBoy » February 21st, 2019, 6:23 am

tjh290633 wrote:No, it's an artifact of directors' incentive schemes.

TJH

I guess you imply that excessive buying back, when used (to attempt) to raise EPS, whereby EPS is one of the criteria used to measure the board's performance. But if EPS is successfully raised then surely all shareholders benefit - since more EPS has to potential to facilitate a growing dividend policy?

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Re: SLA share purchases

#202800

Postby Dod101 » February 21st, 2019, 6:40 am

There is no simple explanation for share buybacks. There are multiple reasons for them and it is up to us investors to look at each one to seek the reason for it in the individual circumstances. No one has mentioned the $25 billion buyback by Shell. If TJH believes that that is 'an artefact of director's incentive schemes', I would have to disagree with him.

We simply cannot say 'Share buybacks bad, special dividends good'.

Dod

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Re: SLA share purchases

#202821

Postby Arborbridge » February 21st, 2019, 8:30 am

TheMotorcycleBoy wrote:
tjh290633 wrote:No, it's an artifact of directors' incentive schemes.

TJH

I guess you imply that excessive buying back, when used (to attempt) to raise EPS, whereby EPS is one of the criteria used to measure the board's performance. But if EPS is successfully raised then surely all shareholders benefit - since more EPS has to potential to facilitate a growing dividend policy?


I think the feeling is that the Directors' resulting payout is disproportionate to the tiny effect for shareholders.

We buy shares with hard earned cash, but their incentive scheme shares are thrown in for free - and should they be allowed to engineer an additional profit for themselves by artificially increasing the eps? It has the ring of corruption about it - that those who control the fiddle factor levers also benefit, has the ring of corruption about it. The rest could be just window dressing to hide to snouts in the trough.

That, however sensible the arguments might be, is behind this discussion, I suspect.

Arb.

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Re: SLA share purchases

#202855

Postby scrumpyjack » February 21st, 2019, 10:38 am

SL did return most of the proceeds of the Phoenix deal to all shareholders via a capital return and share consolidation, and are also having a share buyback (£1 billion capital return, £750 m buyback). Most of their previous returns have been to all shareholders with an accompanying consolidation.

This all seems fairly reasonable. A more justified criticism is of the directors appalling performance in managing the business so that there have been huge outflows of funds and a collapsing share price. It can't help that they have 2 chief executives.

I'm with Dod on this - there are many reasons for doing share buybacks and to try to tar all of them with the accusation that the directors are simply trying to benefit themselves is not reasonable.

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Re: SLA share purchases

#202880

Postby Gengulphus » February 21st, 2019, 11:44 am

TheMotorcycleBoy wrote:
tjh290633 wrote:No, it's an artifact of directors' incentive schemes.

I guess you imply that excessive buying back, when used (to attempt) to raise EPS, whereby EPS is one of the criteria used to measure the board's performance. But if EPS is successfully raised then surely all shareholders benefit - since more EPS has to potential to facilitate a growing dividend policy?

The trouble is that share buybacks and many director incentive schemes combine to give the directors an opportunity to manipulate their incentives upwards unreasonably by choosing to do share buybacks. And IMHO, the actual problem that is the root cause of that trouble is not share buybacks, but poorly-designed director incentive schemes. And so it's those incentive schemes that people's ire should be directed at (*), not share buybacks!

"Poorly-designed" is of course from the shareholder point of view - doubtless some directors think the incentive schemes are very well-designed indeed...

(*) Or at least, their ire with respect to that particular trouble. There are others, such as the tendency for buybacks to buy high and not buy low. I particularly dislike announcements of buyback programmes that are definitely going to put £Xm into buying back shares in the next Y months - i.e. that pre-announce definite figures for both the amount of money to be spent and the period over which it will be spent. That frankly is the behaviour of a mug purchaser and it encourages all would-be sellers of shares to put their target prices up. I.e. by announcing buybacks that way, companies encourage market prices upwards and thus help to ensure they buy high - or in other words, the market can see a mug coming! (And will very happily encourage such mug behaviour...)

Gengulphus

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Re: SLA share purchases

#202905

Postby TheMotorcycleBoy » February 21st, 2019, 12:56 pm

GoSeigen wrote:
Dod101 wrote:Sadly, at least in my opinion, pyad does readers no favours by expressing the views he does and by the way he expresses them. Share buybacks are used for a variety of reasons and I think that they are an efficient way for a company to reduce its capital base. The whole point of the sale by SLA of Standard Life's life insurance business to Phoenix Holdings was to become a 'capital light' investment manager. Share buybacks are an efficient way of reducing the capital in the business by reducing the number of shares in the market....

Dod


Most of this is spot on, but share buybacks do NOT reduce a company's capital. They have to be funded from distributable reserves.

GS

I was pondering how a firm balances it's books re. buybacks, and I'm of the view, that by most measurement standards, buybacks will reduce the firms capital (e.g. the CE and E in ROCE and ROE).

The company accounting equation:
Equity = Assets - Liabilites

So when a firm buys back, the funds to buy the shares comes from assets, in particular cash. So the RHS of the above equation must be reduced e.g. if £50m of stock is bought back then we must decrement one of the accounting buckets by 50m. Correct? But the equation must still balance, else it ain't a very good equation. So a corresponding reduction by 50m surely has to happen on the LHS.

What I'm not 100% on is the name of the accounting bucket on the equity side to decrement, as I'm away from home, I just quickly glimpsed at the statement of equity for Marshalls Plc on page 76 right here: https://www.marshalls.co.uk/documents/r ... report.pdf. I can see only two candidate negative buckets- "Own Shares" and "Consolidation Reserve", I assume that if Marshall did the buyback then one of those two would be decremented by the 50 mil.

Anyway the capital base, at least in the form of Capital Employed (Total assets - Current liabilities + Short term borrowings) , or in the form of Total Equity, is most certainly reduced by the tune of 50m after the necessary adjustment on recording a buyback transaction.

Other accounting details I'd like to know more of, is that to keep everything above board and squeaky clean, presumably different entries must be recorded in one of the above equity account buckets for each buyback tranche e.g.

400,000 shares @ 250p
350,000 shares @ 260p
and so on....

Finally, I apologise if this is off-topic for the HYP board, (I wish it could be in the "Company Analysis" board...) but anyway threads and discussions form in their own way, and as Dod and GS had already started chatting in this vein, I thought I'd continue the debate here....

thanks Matt

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Re: SLA share purchases

#202917

Postby Dod101 » February 21st, 2019, 1:30 pm

Fundamentally I think that The MotorCycleBoy is correct, that the LHS must be reduced. The company is after all buying back its own shares. GS I think is being somewhat pedantic with his cryptic comment and has so far not expanded on it.

Dod

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Re: SLA share purchases

#202977

Postby Alaric » February 21st, 2019, 5:14 pm

Dod101 wrote: The company is after all buying back its own shares.


They are reducing capital employed.

There's an accounting line in the sand where capital employed is separated into "original" capital and accumulated profits ("reserves"). Distributions and buybacks are most simply made from accumulated profits. Making them from "original" capital seems to involve cancelling shares and issuing new ones of a lower face value.

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Re: SLA share purchases

#203057

Postby GoSeigen » February 22nd, 2019, 12:03 am

TheMotorcycleBoy wrote:
GoSeigen wrote:
Dod101 wrote:Sadly, at least in my opinion, pyad does readers no favours by expressing the views he does and by the way he expresses them. Share buybacks are used for a variety of reasons and I think that they are an efficient way for a company to reduce its capital base. The whole point of the sale by SLA of Standard Life's life insurance business to Phoenix Holdings was to become a 'capital light' investment manager. Share buybacks are an efficient way of reducing the capital in the business by reducing the number of shares in the market....

Dod


Most of this is spot on, but share buybacks do NOT reduce a company's capital. They have to be funded from distributable reserves.

GS

I was pondering how a firm balances it's books re. buybacks, and I'm of the view, that by most measurement standards, buybacks will reduce the firms capital (e.g. the CE and E in ROCE and ROE).


Matt, you don't mention Capital Redemption Reserve in your post.

The relevant text from the Companies Act 2006, Part 18, s692 reads:

a)a limited company may only purchase its own shares out of
(i)distributable profits of the company, or
(ii)the proceeds of a fresh issue of shares made for the purpose of financing the purchase, and
(b)any premium payable on the purchase by a limited company of its own shares must be paid out of distributable profits of the company [...]


and the relevant text from Part 18, s706 reads:


706Treatment of shares purchased
Where a limited company makes a purchase of its own shares in accordance with this Chapter, then—
(a)if section 724 (treasury shares) applies, the shares may be held and dealt with in accordance with Chapter 6;
(b)if that section does not apply—
(i)the shares are treated as cancelled, and
(ii)the amount of the company's issued share capital is diminished accordingly by the nominal value of the shares cancelled.




and the relevant text from Part 18, s733 reads:

733The capital redemption reserve

(1)In the following circumstances a company must transfer amounts to a reserve, called the “capital redemption reserve”.

(2)Where under this Part shares of a limited company are redeemed or purchased wholly out of the company's profits, the amount by which the company's issued share capital is diminished in accordance with—
(a)section 688(b) (on the cancellation of shares redeemed), or
(b)section 706(b)(ii) (on the cancellation of shares purchased),
must be transferred to the capital redemption reserve.



Sums in the Capital Redemption Reserve may not be used for distributions, so remain part of the company's share capital. I don't intend to expand on this, because I haven't the inclination and it would probably be way off topic, but a good Company's Act textbook should cover it adequately.

I think it would be safe to say that the law is pedantic about these matters!


GS

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Re: SLA share purchases

#203062

Postby Gengulphus » February 22nd, 2019, 4:43 am

Alaric wrote:There's an accounting line in the sand where capital employed is separated into "original" capital and accumulated profits ("reserves"). Distributions and buybacks are most simply made from accumulated profits. Making them from "original" capital seems to involve cancelling shares and issuing new ones of a lower face value.

Just to clarify that: The items listed under "Capital and reserves" on a company's balance sheet are either "distributable" or "non-distributable". Only distributable reserves can be used for distributions and buybacks, and they may not be driven negative or further negative by those uses. The main distributable reserve is normally the one for accumulated profits (which I've seen various names for, such as "retained earnings" or "profit and loss reserve"), and it can be negative as a result e.g. of having been driven down to a low figure by paying dividends and the company then having made a loss.

The main non-distributable reserves are "Share capital" and "Share premium". Share capital is basically just the total nominal value of the shares in issue - so if there's only one class of shares in issue, it's just the number of shares in issue times the nominal value per share. The share premium reserve arises because companies normally raise much more than the nominal value of a share when they issue new shares: it is basically the total over all issued shares of that premium obtained over their nominal value. (And incidentally, it's never negative: companies are not allowed to issue shares for less than their nominal value.)

Although distributions and buybacks may not be made from non-distributable reserves, the same effect can be achieved in two steps by reclassifying (and generally renaming) the non-distributable reserve as distributable, then using it for distributions and/or buybacks. The first of those steps does however require both shareholder and Court approval, and I believe the company's creditors can raise objections to it with the Court. So taking it involves significant administrative and legal costs for the company.

Other than the admin and costs, that first step is generally fairly simple when the company wants to use its share premium reserve for distributions and/or buybacks - it just involves reducing the share premium reserve and increasing or creating a distributable reserve correspondingly. The process is more complicated if they've exhausted the share premium reserve and any other non-distributable reserves than the share capital: to reduce the share capital, they have to do a share reorganisation that reduces the number of shares in issue and/or the nominal price of a share (without increasing the other one correspondingly). A typical way to do that is to subdivide Ordinary shares into new Ordinary shares and Deferred shares, with the Deferred shares being given part of the nominal value but being made practically worthless and redeemable by the company for effectively nothing, then later redeeming and cancelling the Deferred shares (an example of that is Segro's rights issue in 2009, though that was done to get around the awkward fact that the nominal value of the shares was 27 1/12 pence and they wanted to issue the rights issue shares for 10p each rather than to make reserves distributable).

If anyone is wondering why they've never heard a company doing something like that, by the way, it's the sort of corporate action that companies tell their registered shareholders about via their registrars (often in excruciating detail!), but that nominee brokers don't usually pass on to their customers unless it's part of a more obviously relevant corporate action (such as that rights issue) and even then, it's typically in detail that gets simplified away in the interests of conciseness. So not having heard about any such actions can very easily be caused by holding one's shares in a nominee account - as well as for more obvious reasons such as not having had enough holdings for long enough to make it particularly likely that any of them has had cause to do such an action.

One other important point to note about the legal restriction on driving distributable reserves negative or further negative with distributions or buybacks is that it is a restriction on companies, not on groups of companies. So if you want to know where a company lies with respect to it, you need to look at the parent company balance sheet, not the consolidated balance sheet. For instance, BAE Systems' annual report for 2017 shows retained earnings as -£2,693m of the consolidated balance sheet (on page 146 of the report) but +£2,600m on the parent company balance sheet (on page 203 of the report). It's the latter that determines the company's ability to pay dividends, so it hasn't had any problems doing so.

Gengulphus

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Re: SLA share purchases

#203067

Postby TheMotorcycleBoy » February 22nd, 2019, 6:34 am

GoSeigen wrote:...I don't intend to expand on this, because I haven't the inclination and it would probably be way off topic, but a good Company's Act textbook should cover it adequately.

Fair enough. But I guess that what you allude to below:

GoSeigen wrote:Matt, you don't mention Capital Redemption Reserve in your post.

The relevant text from the Companies Act 2006, Part 18, s692 reads:

a)a limited company may only purchase its own shares out of
(i)distributable profits of the company, or
(ii)the proceeds of a fresh issue of shares made for the purpose of financing the purchase, and
(b)any premium payable on the purchase by a limited company of its own shares must be paid out of distributable profits of the company [...]


and the relevant text from Part 18, s706 reads:

706Treatment of shares purchased
Where a limited company makes a purchase of its own shares in accordance with this Chapter, then—
(a)if section 724 (treasury shares) applies, the shares may be held and dealt with in accordance with Chapter 6;
(b)if that section does not apply—
(i)the shares are treated as cancelled, and
(ii)the amount of the company's issued share capital is diminished accordingly by the nominal value of the shares cancelled.


and the relevant text from Part 18, s733 reads:

733The capital redemption reserve

(1)In the following circumstances a company must transfer amounts to a reserve, called the “capital redemption reserve”.

(2)Where under this Part shares of a limited company are redeemed or purchased wholly out of the company's profits, the amount by which the company's issued share capital is diminished in accordance with—
(a)section 688(b) (on the cancellation of shares redeemed), or
(b)section 706(b)(ii) (on the cancellation of shares purchased),
must be transferred to the capital redemption reserve.


Is that a stock buyback, in accounting terms, is merely an asset transfer, i.e. cash->certificates of some form, and hence the equation I referred to here still balances because the assets part of the RHS meets no quantitative change......hence my earlier hypothesis (i.e. an asset entry is reduced, therefore an equity entry is reduced, hence the capital base decreases) is incorrect?

thanks Matt

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Re: SLA share purchases

#203123

Postby pyad » February 22nd, 2019, 10:33 am

Matt, it's quite simple and the introduction of company law is irrelevant for this purpose here of investigating the effect of buybacks on a balance sheet and the shareholders' interest in the company.

Buybacks reduce shareholders' equity (SE). In accountancy terms, the summarised bookkeeping entries of a buyback are debit SE and credit net debt with the amount expended on the buyback or in plain English, you increase net debt and reduce SE. Consequently gearing (net debt/SE) will be hit doubly by both increased debt and reduced SE.

SE is the total of share capital and various reserves and is the same figure as net assets. But how SE is split between the share capital and various reserves and how they are treated in company law etc. does not matter for the purpose of examining the effect of buybacks on a balance sheet.

You could describe a buyback as swapping equity for debt as the former reduces and the latter increases. Not a desirable way to proceed as it increases the risk of the business.

I've noticed that this deleterious effect on debt and gearing is rarely mentioned when buybacks are discussed. But it is a real and further negative outcome of this insidious action.

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Re: SLA share purchases

#203126

Postby TheMotorcycleBoy » February 22nd, 2019, 10:46 am

pyad wrote:It's quite simple and the introduction of company law is irrelevant for this purpose here of investigating the effect of buybacks on a balance sheet and the shareholders' interest in the company.

Buybacks reduce shareholders' equity (SE). In accountancy terms, the summarised buyback entries are debit SE and credit net debt with the amount expended on the buyback or in plain English, you increase net debt and reduce SE. Consequently gearing (net debt/SE) will be hit doubly by both increased debt and reduced SE.

SE is the total of share capital and various reserves and is the same figure as net assets. But how SE is split between the share capital and various reserves and the how they are treated in company law etc. does not matter for the purpose of examining the effect of buybacks on a balance sheet.

You could describe a buyback as swapping equity for debt as the former reduces and the latter increases. Not a desirable way to proceed as it increases the risk of the business.

Thanks pyad,

So given that I don't know how to do double entry accounting as yet (but I'd love to read and learn more e.g. about DEA, and in particular, about company equity treatment in general e.g. here, so if you know of a reasonably short+cheap book I could read I'd appreciate a recommendation).

Anyway regards my lack of double entry awareness how wrong was my model of a buyback regards cash and equity that I iterated here? (Don't worry you can be as harsh as you like, I don't hurt easily...).

many thanks
Matt

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Re: SLA share purchases

#203130

Postby Dod101 » February 22nd, 2019, 10:55 am

pyad assumes that buybacks are funded by debt. It is not as simple as that because buybacks could (and many would argue should) be funded by surplus cash on the Balance Sheet. It is most certainly not the case that buybacks are always funded by debt and even if they were, some debt is usual in any trading company. It is only if it becomes excessive (and that depends on the nature of the business, level of interest of the borrowings and such matters) that it becomes a problem.

I am no longer surprised, but it is a shame, that pyad is always so black or white when discussing investment matters. Investment is more often a shade of grey and picking a path which is appropriate to a business and the economic environment at the time.

Dod


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