In theory, companies should only buy back their own shares when they're cheap, but this rarely happens. Andrew Lyddon, author on The Value Perspective blog, highlights a case where it has.
The share buyback can be a beautiful thing – at least in theory. The idea is that a company buys back some of its own shares from existing investors and, because these are no longer publicly available, the market value of the shares that are still in issue should increase – at least in theory. And the reason we keep saying “in theory” is it does depend on the company buying back its shares at a suitably cheap valuation.
Unfortunately, as we observed in Morally neutral, history suggests corporate managers tend not to be the most natural of counter-cyclical investors, buying their own shares – not to mention whole other companies – when prices are too high and having share issues when prices are too low. All of which makes the current plans of California-based company Bridgepoint Education particularly interesting.
Bridgepoint is one of a number of for-profit businesses that run educational institutions in the US for people looking to gain extra skills and qualifications outside the usual channels. Some are successful operations while others have attracted some bad publicity for the sector – the now-defunct Trump University, which ran a real estate training programme between 2005 and 2010, being the most high-profile example.
The sector, which we touched on a few years back in Perverse psychology – also in the context of share buybacks – has traded on cheap valuations for some time even though a number of the businesses are financially strong, with healthy cash balances. That combination goes a long way to explaining why, here on The Value Perspective, we own several for-profit education companies across our portfolios, including Bridgepoint.
While it may be perfectly logical for companies to build up their reserves at times of uncertainty, investors can grow quite disgruntled when they believe a business is allowing its cash to sit around, apparently doing nothing. As a result, Bridgepoint has found itself under growing pressure to explain what it might do with its own cash balance – and in March it came out and said it would be embarking on a share buyback programme.
Not your run-of-the-mill buyback
This is not – in terms of size or structure – your run-of-the-mill buyback. For one thing, Bridgepoint has agreed to buy back 18 million shares – of the 46 million in issue – from its largest shareholder, the private equity company Warburg Pincus. It is doing so at a point where its shares are very heavily depressed in valuation terms. For about $150m (£117m) then, it is retiring 40% of all of its shares in issue.
Now, clearly there is more to this deal than what is in the public domain – after all, private equity firms do not make a habit of selling significant shareholdings on depressed valuations, just on a whim. It could be, for example, that Warburg Pincus is looking to create more liquidity in the market for Bridgepoint shares – in effect, make them easier to buy and sell – ahead of selling the remainder of its stake further down the line.
On The Value Perspective, we are not privy to the details of the deal so we do not know the explanation. What we do know, however, is while the theory runs a company should only buy back its own shares when it believes them to be cheaply valued, this happens so rarely in practice – and certainly not in such an extreme way – the Bridgepoint plan is well worth bringing to your attention. How it plays out could prove educational.
Andrew Lyddon is an author on The Value Perspective, a blog about value investing. It is a long-term investing approach which focuses on exploiting swings in stock market sentiment, targeting companies which are valued at less than their true worth and waiting for a correction.Click here and enter your email to receive a weekly round-up of investment ideas.
Important Information: The views and opinions contained herein are those of Andrew Lyddon, Fund Manager, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.