The Dynamics of Shareholder Capital – Part III

In yesterday's issue of HX Daily, we discussed the – sometimes controversial – topic of share buybacks.

We went through a scenario where a company has utilized a consistent policy of share buybacks across thirty years, creating a tremendous amount of shareholder value.

The example we used – AutoZone Inc. (NYSE: AZO) – is likely the most successful use of share buybacks ever. Few (if any) other companies have repurchased as many shares or seen the same share price performance.

Mostly, we believe companies add value with their share buybacks.

It might be an unpopular opinion, but as we said yesterday, we think that management teams and their boards of directors know what they are doing and add value.

Sometimes, though, the share buybacks do NOT add value. Occasionally, they can even lead to disaster.

Some of the most well-known instances are the large share buybacks that were done by the major banks going into the collapse of Lehman Brothers and the Global Financial Crisis in 2008.

The biggest banks bought back a vast amount of stock but then needed financial aid from the government. Citigroup Inc. (NYSE: C) bought back over $20 billion of shares from 2004 through 2008 but required a roughly $45 billion government bailout.

Lehman Brothers bought back $2.6 billion of stock in 2007 and another $1.5 billion in the first half of 2008. All this just six months before going bankrupt!

Clearly, these buybacks did not produce value for their shareholders.

However, given the financial leverage involved, financial companies are a very particular group. We think they can be used positively by financial companies, but there is always going to be a unique risk associated with them.

A better example of a failed share buyback is the now-bankrupt retailer Bed, Bath and Beyond – formerly listed on NASDAQ as BBBY.

BBBY shared some commonalities with AZO. Both were successful retailers servicing a relatively mature and stable area of the economy. AZO was in the automobile business, and BBBY sold houseware, furniture, and specialty items for the home.

One could argue that BBBY had the better end market when you look at annual growth over time.

In 2004, BBBY decided to deploy a strategy similar to AZO's to buy back shares aggressively. Here is a table showing the diluted shares outstanding from 2004 through 2023…

Across 20 years, they reduced the share count by almost two-thirds. 

At the time, it made sense as they had no debt and had been growing revenue very nicely. Here are those tables…

From 2004 to 2015, the company saw revenue grow from $4.5 billion to almost $12 billion.

From that period onward, though, their revenue growth began to stall. This is despite a decent economy and housing market.

As its growth began to stall, the company decided to layer on debt for the first time and continue – if not accelerate – the share buyback.

We don't think there was necessarily anything wrong with this strategy. We didn't share AZO's revenue and debt charts, but they have also seen periods of muted revenue growth and used debt to buy back shares.

Like AZO, BBBY also saw decent share price performance. Here is the stock price chart from 2004 until going bankrupt in 2023…

The stock doubled over the decade from 2004 to 2014. Then, it stalled along with sales despite the continued share buybacks. This might have been a message to management.

The big difference between the two companies is how their end markets eventually played out.

COVID-19 impacted AZO, but it is relatively immune to online purchasing. Folks just aren’t used to ordering automotive replacement parts and accessories online.

Unfortunately for BBBY, the same was not valid for housewares. COVID was a particularly damaging situation for them…

Although they had a robust online business, their stores were closed. This was when people began to spend a ton of money on their homes. They were stuck there and – if they didn’t lose their jobs – had money to spend and lots of free time.

This led to a massive migration to online selling of housewares. Amazon.com, Inc. (NASDAQ: AMZN) attacked the market very aggressively.

Again, BBBY had a good online presence, but it was impossible to compete with Amazon's scale, and the cost of

its stores hurt them.

Looking at the chart of their debt, you can see a significant uptick as they took on debt to get through this period.

It was AFTER COVID-19 that management made their fundamental mistakes.

Management did not understand the magnitude of the migration of houseware buying online, nor that it would persist. This meant that their revenue outlook was going to be impacted.

However, they didn't recognize this and returned to buying back stock as aggressively as before, even despite the higher level of debt.

This fatal combination eventually drove the company to file bankruptcy in April of 2023.

Have you seen an example of a company destroying value through share buybacks? Share it with us in the comments section online or at [email protected].

Do we think the buybacks at BBBY were a mistake?

Up until 2015, we don't think so at all. The aggressive buybacks made sense, considering their end market and no debt. They weren't necessarily a mistake from 2015 until COVID-19 in 2020, as revenues were stable, and the business was still generating much cash.

It was not recognizing the change in the environment that would persist after COVID (and the higher debt load) that would doom the company.

Could something similar happen to AZO someday?

Maybe. Perhaps some change in automobile maintenance around electric vehicles will impair their business, and they will suffer the same fate.

There is a risk to the future of any business.

Like any aspect of a company's financial operations, we think share buybacks – when used correctly – can drive a lot of value. The world changes, though, and ultimately, it comes down to management's ability to recognize those changes and react appropriately.