When the stock is cheap and there's cash on hand, a robust buyback of shares is the ticket to gains.
That's the conventional wisdom, and it could certainly fit Research In Motion Ltd., as the company sits in the doghouse after ratcheting down first-quarter earnings guidance. RIM has employed stock buybacks in the recent past, so much so that the Toronto Stock Exchange says the company must wait until July before starting again.
If RIM announces another share repurchase, however, investors should be wary as to whether the company's management has picked the best use of its cash. The next buyback won't help as much as the last, and the company could be better served by reinvesting in its business.
Let's take a moment to give RIM its due. It is the only company to make the Top 10 of the Barron's 500 list for sales growth and cash flow in each of the past two years. Despite its cut in first-quarter guidance, the company maintained its target for the year, and it has a history of beating consensus. Its sales grew 33 per cent in the past year, with particularly strong results in dozens of international markets.
Investors, though, are looking forward, obsessing over the company's diminishing competitiveness in the North American consumer market, where the Apple iPhone and Google Android systems are gaining market share. The lukewarm-to-hostile reviews of RIM's PlayBook tablet have added to the hand-wringing. So now we have a stock that, at less than $45 (U.S.) a share, is trading below six times the $7.50 in earnings per share that management expects in the current fiscal year.
Wouldn't a buyback help RIM's share price? While it has in the past, the effects were not as pronounced as you might have thought.
Think P/E
Share buybacks help companies because they reduce the number of shares outstanding. This means that earnings get divided up among fewer shares, so profits per share increase. All things equal, that should translate to a higher share price.
But the precise impact hinges on a company's price-to-earnings (P/E) ratio. The result from a buyback is powerful when a company has a P/E of 15 or 20. But when a stock has a P/E multiple of six, as RIM does, adding pennies per share in earnings doesn't do much to move the overall price.
The two repurchase programs that ran from November, 2009, to the fall of 2010 cost $2.9-billion and took out nearly 50 million shares, roughly 10 per cent of RIM's outstanding amount. Add those shares back in, and the current-year guidance would be more like $6.85 a share. At six times guidance, that would translate into a current share price around $41 - about $3 less than current levels.
Similarly, a new program that takes out 5 per cent of current shares outstanding could add roughly 40 cents to earnings per share. But at its current multiple of six, that adds only a couple dollars to the stock's price.
In contrast, making moves that could reinvigorate investors' enthusiasm for RIM, and thereby raise the multiple, would have a much larger impact. Boosting the P/E multiple to seven, say, would increase the share price by about $7.
Balance Sheet: Wait A Second...
As it weighs its options, RIM has the luxury of cash on the balance sheet. Certainly, it could afford another buyback plan: The maximum program would cost just over $1-billion even at the current depressed prices, and RIM has just over $2-billion in cash, no debt, and operating cash flow of $4-billion last year.
Yet RIM's healthy balance sheet pales in comparison to other tech companies, particularly handset makers.
In an April report, the analysts at CIBC World Markets published a list of the 20 biggest net cash balances in the worldwide tech sector; RIM didn't crack the list, which had a $3.5-billion cutoff. Motorola Solutions, Ericsson, Nokia and Samsung all had between $6-billion and $11-billion in net cash; Apple's net cash balance of nearly $60-billion is almost three times RIM's current market capitalization.
In short, RIM doesn't have so much cash that it can do a buyback and also spend heavily to improve its business, perhaps through acquisitions - which is what some analysts suggest may help RIM's prospects.
Acquisitions
Alexander Peterc of Exane BNP Paribas says that while "on paper a buyback makes sense," he believes RIM would do better with acquisitions in the smart phone software and services area to boost its consumer offering. "I am not sure whether buybacks would actually lift its stock valuation significantly," he adds, saying RIM's smart phone market share, sales mix, new devices, and operating system transition are more important drivers of valuation than the use of excess cash.
Sameet Kanade of Northern Securities says RIM may need to adopt "an aggressive acquisition strategy" toward consumer software. "Maintenance of an aggressive buyback program may indicate further shortfalls at RIM, in our opinion."
Co-CEO Jim Balsillie was non-committal on the analyst call about a future buyback, saying "we balance [buybacks]against what's an appropriate balance sheet … we're very bullish on the long-term prospects of the company, we're very bullish on what we're doing, but it's a high, high turbulence ecosystem."
So turbulent that the shares that RIM spent $2.9-billion to buy back are worth less than $2.2-billion today. A company's managers are supposed to be among the best judges of its share price; RIM's executives may decide to plow more cash into buying back a cheap stock, but investors would be better served if the company addressed some of the issues that make it cheap in the first place.
Special to The Globe and Mail
David Milstead