Corporate Buybacks

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Corporate Buybacks

Postby Pixel8r » Thu Jul 10, 2014 9:44 am » Safari 7.0.4 Safari 7.0.4  Mac OS X Mac OS X  Screen Resolution: 1920 x 1200 1920 x 1200

Since the credit crunch in 2008 there has been ever increasing amounts of share buybacks by corporations.

I found this good explanation of how the buybacks are working;

We presently have one of the biggest tax ruses in history going on as the Fed and US Treasury desperately try and increase the wealth effect to elevate asset prices and finance government debt. To make low bond yield seem relatively attractive (at present historic lows), the Fed needs to get stock yields down via elevating stock prices. Corporations have been willing accomplices in this charade.
 Dividend payout rate approximates the S&P 500 average of 2.25% per annum.
 Borrowing costs approximate 3.5% per annum
 Corporate nominal US tax rate 35%
 Assume stock trades at $100/share with 100 shares outstanding,
 Market Capitalization of $10,000 (100 X 100)

A 2.25% Dividend rate means a $2.25 Dividend payout per year.
If we were to borrow $225 to buyback 2 1/4 shares it would cost $7.89 ($225 @ 3.5%)
The tax deductibility of $7.89 at a nominal tax rate of 35% would be $2.76
Therefore our model corporation would save $0.51 ($2.76 – $2.25)) by borrowing to buy back their shares.

I have been trying to understand who is at risk from this?

Lets use Apple as an example, they have a large cash pile but have been issuing bonds heavily at very cheap rates and using the funds to buyback their own shares. They are not at risk because the bonds are covered multiple times by their cash pile. The ones that are at risk are the buyers of the bonds at ridiculously low rates. So who is buying the debt at these ridiculously cheap rates?

Goldman Sachs Group Inc. GS -0.15% and Deutsche Bank AG DBK.XE -1.61% sold the debt for Apple to investors in all corners of the credit markets, from buyers overseas to municipal-bond investors to portfolio managers who typically prefer ultrasafe government debt. Pension funds, insurance companies and hedge funds also joined in the scramble.

So basically the debt is being sold to the public and they will be the ones that are hit. So the central bank ZIRP is causing the public to take on much more risk. As soon as rates start to increase the corporate bonds holders will lose massive amounts, but also at the same time corporation profits will massively reduce.

Not sure how much longer this can go on for but I can hear a sound tick... tick... tick...
"Money is Gold, and nothing else"
(As John Pierpont Morgan once stated under oath before the USCongress and the Pujo Commission in 1912)
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