Let’s buy you out… we’ve got enough cash!

Kenya’s corporate scene was transformed significantly in 2015 following the amendment of the company’s act. This saw many listed public companies change their names with most now ending with the term ‘Plc’. Another newly introduced amendment, the first in East Africa was share buybacks. This clause gave leeway for companies to buy their shares in the open market. What followed was several companies amending their articles allowing them to buy their shares as early as 2017.

In the recent past, two closely related entities announced their intentions of buying up to 10% of their issued shares in the next 18 months. This brings us to the question, are Kenyan companies ready for stock buybacks? In my opinion, NO! Kindly follow my way of thinking to fully understand the basis of my assertion.

Firstly, we are a developing economy which means that the government and companies are competing for funds in the capital market. This provides the necessary funds for investment in infrastructure and growth. As such funds are hard to come by for some firms forcing them to rely heavily on retained earnings. Should a firm dig into its retained earnings to buy out its shareholders, they expose themselves to liquidity risk in an environment where the cost of borrowing is high. Therefore, stock buybacks are not ideal.

Another reason is that investors like gees that lay golden eggs. They will therefore invest in stocks of innovative firms that plough back some of their profits into research and development, guaranteeing future income in form of dividends and capital gains. Buying out your shareholders simply means that you are not innovative enough to leverage future opportunities that come with technology. Of the two firms buying its stocks, one has for long relied on an old business model. This has seen its revenues and profits decline in recent years as social media went for their primary source of revenue.

Since stock buybacks are a form of financial engineering, a firm’s investment ratios significantly increase after exercising this operation. As such, holdings of remaining shareholders increase as well. The earnings may remain flat, while their price multiples increase with little or no value-added in the form of advanced technology, increased market share, better earnings, and new investments.

Also, share buybacks will at one point give rise to agency problems. Since most managers’ performance is pegged on aspects such as the stock price, most will implement buybacks to access their bonuses. They may also use leverage to finance these buybacks thus exposing investors to financial risks.

To sum up my opinion, our operating environment is very fragile and any major shocks expose most firms to uncertainties that may cause liquidity challenges. Share buybacks are therefore not sustainable for most of our listed firms. A Story is told of the US aviation industry. As everyone knows, airlines are susceptible to liquidity challenges and lower profit margins. On the contrary, these major airlines have spent their free cash flows, (to a tune of $45bn) on stock buybacks since 2014. When the coronavirus pandemic hit, they sought bailouts to the tune of $50bn in taxpayers’ money. They got away with it. Is our government ready to bailout such firms should things go south because of using their cash to buy out their investors? Your guess is as good as mine.

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