Accelerating your buybacks doesn’t accelerate anything

By Werner Rehm , Vartika Gupta, CFA , and Prakshi Gupta

We still see companies using accelerated share repurchases, which are basically designed to increase reported earnings per share (EPS). Unsurprisingly, we think this is probably a waste of management time and, most likely, a slight value drag.

What is an accelerated share repurchase?

• An accelerated share repurchase (ASR) is a share repurchase method that companies execute through transactions with an investment bank (not directly in the open market).
• An ASR allows companies to immediately purchase a large number of common shares at an average market price over a fixed period (usually at a volume-weighted average price or VWAP).
• The company provides an upfront cash payment to the investment bank at the trade date. The bank borrows company shares from other institutional investors. The bank then delivers a portion or all of these shares to the company, and both entities agree to a future settlement (forward contract) on a VWAP basis.
• The investment bank then purchases shares in the open market over some time and returns them to the stock lenders.
• The company settles the deal cash balance with the bank at the settlement date. If the VWAP is less during the averaging period than at the trade date, the company would have paid a lower ASR price than a traditional (spot) repurchase at the trade date and vice versa.

Why is ASR preferred over traditional repurchase?

This mechanism enables companies to repurchase shares immediately while paying a purchase price that mirrors the price achieved by a longer-term repurchase program in the open market (minus fees). Since accounting is purely mechanical, all that matters for EPS is the average number of shares outstanding, which is lower with this method. [1]

Exhibit 1 summarizes the effect for a company that buys back 30 shares over the course of a year, ignoring interest income/expense (which would lower the income in the case of the buyback). If the company buys back ten shares at the beginning of Q2, Q3, and Q4, it will have 985 reported shares outstanding on average [2] and a slightly higher EPS. Under an ASR agreement, ignoring all costs, the company would immediately reduce the outstanding shares to 970, resulting in marginally higher EPS than share repurchases every quarter.

What is it worth?

Let’s start with a simple assumption: No cost for the accelerated share repurchase and no other value drag. For this to impact shareholder value, you must believe that EPS matters for long-term shareholder value. This has been disproved many times in theory and market observations.

If it’s not EPS, could there be anything else? Most of these transactions are designed to happen at the beginning of the fiscal year, not at a market low, indicating that the main concern is reported EPS, not market condition. Unless we assume that the bank is good at timing the market (which they might be), there is unlikely any value from market pricing.

Another common reason could be the announcement effect. Through the ARS, senior managers may signal that, in their minds, the stock is undervalued. Or they may project confidence that the company doesn’t need the cash to cover future commitments, such as interest payments and capital expenditures. This is the same as any other share repurchase announcement – the only difference being that the company follows through on day one. This is probably a good thing because there is no real requirement to follow through in most jurisdictions for open market buyback announcements. [3]

However, there are downsides.

• The banks don’t do this for philanthropic purposes—they make money on it, often directly through a fee or shares. This is a direct value drag on investors.
• The company typically pays the cash all in one go to the bank upfront. Later in the year, flexibility for cash use disappears. You can’t stop this.
• Investors are short-selling shares to the banks, settled later through share delivery.
• Unless it’s a high-performing company with a lot of excess cash, ASR is not a signal for a growth-inducing strategy. It can be considered a poor utilization of a company’s capital.

Generally, paying cash for an accounting effect is not a good idea. Investors are intelligent and may even be skeptical when you spend management time designing transactions like this.

[1] Many ASR programs have terms that vary from this basic transaction and include additional features that may complicate the accounting analysis.

[2] Shares are reported as weighted shares outstanding. Here is a simple example of how it works.

[3] In some jurisdictions, companies are required to follow through with the announced repurchase volume in the announced timeframe.