Wednesday, June 2, 2010

Value Buybacks

When management's interests are aligned with those of shareholders, agency costs are minimized. Management and shareholder interests are most aligned when the chief executive has a large portion of his wealth invested in the business; in this way, the manager is also a shareholder. This incentive alignment leads to actions that are shareholder friendly, which is not the norm in many companies.

Jewett-Cameron (JCTCF) is a company we discussed two months ago that not only appears to have a well-aligned incentive structure, but appears to trade at a discount to its intrinsic value. When these two circumstances appear in combination, you are likely to see a share buyback. Indeed that's exactly what happened, as last week the company issued a release that it would re-purchase its shares. But while share buybacks are rather common, the level of communication (continuing with this theme, as we have recently discussed how management's communication with shareholders can lead to either positive or detrimental results, depending on the extent to which it is done) in this release was a step above what shareholders are accustomed to.

First of all, the company stated that it would only purchase shares at prices below $7/share. (The current price is around $6.70.) In almost all cases, shareholders are not given any information of this nature, making it difficult for shareholders to include buybacks as part of their valuation models since the purchase prices paid for shares do not become public until well after the fact.

Second, the buyback program covers a period of only 2.5 months. (Most buyback periods are one year long, and even then many are not completed during this time frame.) This sends a strong signal that the buyback will be immediate (subject to the paragraph above) in the company's budget worksheet, removing any fears that this is an attempt to talk the stock up rather than implement real action.

Finally, the buyback program covers a massive 18% of Jewett's outstanding shares, whereas most buyback programs cover less (sometimes far less) than 10% of the company's shares. As a result, it can serve to significantly increase the intrinsic value of each share.

When management has a stake in the company, it will make decisions that are good for shareholders. When those decisions are communicated in advance, investors can benefit, particularly if a stock is not well followed. (In Jewett's case, the stock price changed by just 0.3% on the day following the announcement.)

Disclosure: None


Amit said...

This is a great find. There has got to be a catch, Saj - but good work nevertheless finding this gem.

How do you claim that the 3 month window versus the 12 month window somehow alleviates any 'talk up the stock' concerns. They are not mandated to buy a single share back under any kind of law. They in fact expressly reserve the right to redact arbitrarily for any cause.

This could easily be a short-term stock-pump press release. Here's my dilemma about all this: why in the WORLD would a company offer a press release DECLARING that they are about to buy back 17.6% of the company's market outstanding shares below a certain threshold that is less than the company's current stock price? Why announce this kind of strategy, when such an announcement would sabotage the company's own interests to buy the shares cheap?

One trigger for a company to buy its own stock back is if its own stock is cheap. At this point, the company's own stock is equivalent to any other common stock out there in the world. If the company decided, instead of buying back its own stock, to buy back some other net-net because it feels it is undervalued - and a good investment of company cash - would it announce to the world that it is about to buy that net-net?

I think not. This smells funny, what do you think?

Saj Karsan said...

Hi Amit,

I agree they don't have to buy anything, but three months gives them a shorter time frame to work with. I.e. There will be questions about why no shares were purchased in just three months, as opposed to in four quarters.

I understand what you're saying - that the announcement appears to sabotage the company's buying plans, but I know that in Canada companies have to make their buyback intentions fairly clear, so that might apply here as well.

Andrew said...


would you have any concern that the company is trying to go dark and delist? I was unable to find the number of shareholders listed in their 10K or Q (which obviously would have changed by now).


Saj Karsan said...

Hi Andrew,

Of course, that is a possibility. But I don't think it's very probable, as the CEO owns a large chunk of shares and that action would reduce his wealth (private companies trade at lower multiples to public ones). I think he's trying to do the opposite with this buyback: raise the P/E.