A Tale of Two Buybacks

There have been a lot of big name investors in the news recently, including the trio of Warren Buffett, Kirk Kerkorian, and Carl Icahn. The media tends to lump all three men into the same group of people investors should pay great attention to. After all, when Buffett disclosed he bought Anheuser Busch (BUD) stock weeks ago, the stock jumped from $45 to $48 in a single day. Kerkorian issued a tender offer for General Motors (GM) shares that resulted in the largest one day gain in the stock in more than a decade.

Icahn perhaps deserves less attention. His track record is not as solid as Buffett or Kerkorian, and Wall Street evidently realizes that his shareholder activism efforts with the likes of Blockbuster (BBI) don’t always add any value for stock owners. In fact, when Icahn recently released a list of stocks in which he purchased stakes in recent weeks, most of the stocks barely budged.

Today I will focus on two stock buybacks, one of which was precipitated by Icahn’s discontent with the management of Kerr-McGee (KMG), and the other non-Icahn related buyback that resulted from a huge cash stash at Motorola (MOT). As you can see from the chart of today’s trading below, the stocks have reacted differently to the news of their respective buybacks.

First, the good news. Motorola has $6 billion of cash on its balance sheet currently, net of debt. CEO Ed Zander today announced that the company will buy back up to $4 billion in stock, about 10% of the total outstanding shares. Both Motorola and Nokia (NOK) have huge cash balances that have contributed to Peridot’s extreme interest in the stocks over the last year. Investors should always pay attention to balance sheets, in addition to earnings per share. When companies are flush with cash, they will usually do something good with it eventually, just be patient. MOT shares have been up between 3 and 4 percent today.

As you can see, Kerr-McGee shares are faring much worse today, falling by as much as 8 percent. Here’s a quick synopsis of the story there.

Icahn, unhappy with the management of KMG (despite the stock’s rise from $50 to $80 with the last 12 months), threatened last month to attempt to get elected to the company’s Board of Directors. Icahn agreed to abandon the effort after Kerr-McGee launched a “Dutch Auction” tender offer for 46.7 million shares. The move would cost $3.97 billion based on a purchase price of $85 for each KMG share, in order to avoid a proxy battle with Icahn.

With KMG shares trading at $74, Icahn basically has forced Kerr-McGee to buyback 29% of its total shares outstanding for $85 apiece. Today, the stock opened at $69. How exactly is buying back stock at $85, when your share price is $69, good for shareholders? That’s a $16 per share premium to the price on the open market. Icahn evidently thinks that is a good investment of nearly $4 billion for the company.

You know what makes it even worse? KMG doesn’t even have the $4 billion to buy the stock with, so they are borrowing the money. The company secured a $5.5 billion credit facility to fund the purchases. So, in addition to the $16 per share premium it is paying (an extra $747 million above market value) Kerr-McGee also has to pay interest on the entire amount.

Something tells me Warren Buffett would never force a company he owned a significant stake in to throw away money like that, let alone money they needed to borrow to do so.

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