Wealthy Nations Daily Update - Apple and Buybacks Performance

Buyback season apparently continues unperturbed with Apple yesterday completing a $12bn bond issuance. Apart from a $1.5bn green bond (for environmental and public relation purposes) much of the debt will fund buybacks at current ‘knockdown prices’ taking advantage of shares trading between $90-$100 this year - more than 25% below their peak of around $130 in mid-2015. The favourable timing also takes advantage of a lull in the recently agitated bond markets whist tapping into its hankering for AAA and high AA rated credit at a time when historically few other companies are doing so. Year-to-date US debt sales are at the lowest levels in over two decades. Hence Apple received over $28bn of orders across nine tranches on what is the second largest bond sale of the year (second only to AB InBev’s $46bn fund raising for the acquisition of SABMiller).

The deal quenches investor demand for high grade credit but also clearly offers value for the issuing company: locking in relatively low borrowing costs, associated tax advantages… and of course better managerial pay from any earnings related compensation. But what are the other associated benefits and risks for bond and equity holders respectively?

To outline the recent trend, buyback amounts in the SandP 500 have been trending upwards for the past decade, albeit with a sharp drop off following the GFC. Up until 2003 monthly buybacks typically remained within the range of $10-15bn, but from 2004 to 2007 they rose sharply to $55bn per month before dropping back to $20bn over the subsequent 18 months. Since mid-2009 they have again rose to around $45bn per month, accounting for around 60% of the index’s overall yield (currently 5% with 3% from buybacks and 2% from dividends). But compare the index’s top 100 constituents most active in buybacks to the index as a whole and you get a clearer picture of the consequences of such activity.

A ratio of the 100 most active companies in buybacks in the SandP 500 versus the overall index does indeed show that from the end of 2008 until early 2015 investors in the former would have increased their returns by an annualised 5.5%. Of course other factors contaminate this result such as the autocorrelation that buybacks occur within companies that have excess earnings with which to consider such schemes. Obviously such companies tend out outperform regardless of buybacks. But the more pertinent warning for equity investors overweight in such self-adorning companies can be seen in the past 12 months of relative performance. Since February 2015 the SandP Buyback 100 has underperformed the overall SandP 500 Index by -8.5%. This risk-off period perhaps points to the increased leverage amongst such habitual ‘buybackers’ and their increased sensitivity to overall market downturns.

Yet the longer term excess returns clearly suggest that companies can effectively increase investor return through the well timed use of buybacks. For asset rich and profitable companies conducting buybacks, such as Apple, any related debt issuance is likely to be mutually beneficial. Efficiencies, diversification, long term investment and capitalising on opportunities are all sensible reasons for wealthy companies (and countries) to issue debt. The countries and companies that we typically invest in are net creditors with long term goals for their borrowing; our investment process helps us identify the best value credits with such favourable fundamentals (and where available sovereign support) avoiding those who continue to borrow at unsustainable levels and for unproductive reasons. Currently Apple 43’s (Aa1/AA+) trade at a spread of around 186 bps, making them an attractive alternative to Treasuries.