Wednesday, November 23, 2011
As Layoffs Rise, Stock Buybacks Consume Cash
When Pfizer cut its research budget this year and laid off 1,100 employees, it was not because the company needed to save money.
In fact, the drug maker had so much cash left over, it decided to buy back an additional $5 billion worth of stock on top of the $4 billion already earmarked for repurchases in 2011 and beyond.
The moves, announced on the same day, might seem at odds with each other, but they represent an increasingly common pattern among American corporations, which are sitting on record amounts of cash but insist that growth opportunities are hard to find.
The result is that at a time when the nation is looking for ways to battle unemployment, big companies are creating fewer jobs, and critics say they are neglecting to lay the foundation for future growth by expanding into new businesses or building new plants.
What is more, share buybacks have not fulfilled their stated purpose of rewarding investors over the last decade, experts say. “It’s a symptom of a deeper problem, which is a lack of investment in the long term,” said William W. George, a Harvard Business School professor and former chief executive of Medtronic, a medical technology company. “If we’re not investing in research, innovation and entrepreneurship, we’re going to be a slow-growth country for a decade.”
Liberal critics insist the trend is another example of top corporate executives raking in an inordinate share of the nation’s wealth, even as their employees suffer.
“It’s an extraordinarily unimaginative way to use money,” said Robert Reich, a former secretary of labor under President Clinton who now teaches public policy at the University of California, Berkeley. After diving in the wake of the financial crisis, buybacks have made a remarkable comeback in recent years, with $445 billion authorized this year, the most since 2007, when repurchases peaked at $914 billion.
But spending on capital investments like new plants and infrastructure has stagnated more broadly in corporate America, confounding efforts by the Obama administration to spur economic growth. Capital expenditures by companies on the Standard & Poor’s 500-stock index are expected to total $546 billion in 2011, down from $560 billion in 2008, according to data compiled by Thomson Reuters Eikon.
The principle behind buybacks is simple. With fewer shares in circulation, earnings per share can rise smartly even if the company’s underlying growth is lackluster. In many cases, like that of the medical device maker Zimmer Holdings, executives are able to meet goals for profit growth and earn bigger bonuses despite poor stock performance.
“It’s clear there’s a conflict of interest,” said Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “Unless earnings per share are adjusted to reflect the buyback, then to base a bonus on raw earnings per share is problematic. It doesn’t purely reflect performance.”
In addition, executives, who are often large shareholders, stand to benefit from even a small, short-term jump in stock prices.
Earlier this month, Pfizer increased its estimate for stock repurchases this year to between $7 billion and $9 billion — essentially spending in one year nearly all of the money it set aside in February for multiyear buybacks. There has been a steady drumbeat of other companies laying off workers even as they have disclosed plans to buy back more stock. On June 23, Campbell Soup said it would buy back $1 billion in stock; five days later it announced plans to eliminate 770 jobs. Hewlett-Packard announced a $10 billion stock repurchase in July, and jettisoned 500 jobs in September after it discontinued its TouchPad and smartphone product lines.
Last month, the first layoffs began at Zimmer’s plant in Statesville, N.C., which is due to shut early next year. The company made splints and tourniquets there for more than three decades. For the sewing machine operators and the rest of the 124 workers at the plant, it is bad news, but it is a different story for Zimmer’s top executives.
Powered by huge stock buybacks — the company bought $500 million worth of its own shares last year, more than twice what it spent on research and development — Zimmer posted earnings growth of 10 percent a share, even though operating income and revenue grew by less than 5 percent in 2010.
That helped its senior management, including the chief executive, David C. Dvorak, collect millions in cash and stock incentive payments by meeting earnings-per-share goals. For example, 50 percent of Mr. Dvorak’s $1.03 million cash bonus was tied to achieving per-share earnings of $4.28 in 2010. The company earned $4.33, but without the share repurchases the company would have made $4 to $4.10 a share.
Investors have not rewarded the strategy, however: Zimmer’s shares have dropped 32 percent in the last five years, while Pfizer’s are down 30 percent in the same period.
Over the last decade, in fact, companies that spent the most on repurchases had a total shareholder return of 37 percent versus 127 percent for companies that spent the least, according to research by Gregory V. Milano, chief executive of Fortuna Advisors, which consults with companies on how to raise their share price over the long term.
In the cases of Pfizer and Zimmer, analysts say the rush to buy back shares crimped development of new products, a prime reason that both companies are experiencing slow revenue growth.
Despite the looming expiration of the patent for its best-selling drug, Lipitor, Pfizer spent more than $20 billion repurchasing shares from 2005 to 2010.
“In that era, it wasn’t the best use of cash,” said Catherine Arnold, an analyst with Credit Suisse. “They should have been doing more to fix the company.”
Matthew Dodds, an analyst with Citigroup, said, “Zimmer has shown little appetite for acquisitions or diversification, yet they don’t sport a pipeline that can drive investor interest."
Nevertheless, Zimmer is on track to repurchase $1 billion worth of its shares this year, double last year’s pace, and it actually borrowed money last quarter to achieve its goal.
In a statement, Zimmer said its bonus programs were “designed to pay for performance,” and that overall compensation strategy was “designed to align the interests of its employees and stockholders.” Zimmer is committed to research and development and the introduction of new products, the company said, adding that the factory closure in North Carolina, while difficult, “is in the best interest of the company’s stockholders.”
Pfizer declined to make an executive available to discuss its policy. But in a statement, the company said it “remains committed to returning capital to shareholders through share buybacks and dividend payments.”
As for the cut in research spending in February, Pfizer said it has “accelerated our research strategy and made important changes to concentrate our efforts to deliver the greatest medical and commercial impact.”
In a conference call with analysts this month, Pfizer’s chief executive, Ian C. Read, said his company would “continually look” for acquisitions that would increase revenue growth. But in deciding how to use the proceeds from recent asset sales, he said “the case to beat is share repurchase.”
Financial institutions, which bought back huge amounts of stock over the last decade at share prices far higher than they are today, do not seem to have learned their lesson either. JPMorgan Chase, for example, spent $4.4 billion repurchasing shares in the third quarter even as its stock fell more than 25 percent.
New York Times
Top U.S. banks told to stress test against severe recession
The Federal Reserve told the largest U.S. banks on Tuesday to test their loan portfolios and trading books against a severe recession and a European market shock.
The most severe point of the test will assume a 13 percent unemployment rate and an 8 percent decline in U.S. gross domestic product.
Some 31 bank-holding companies are being asked as part of their 2012 capital plan review to project revenues, losses and capital positions through the end of 2013 using four different scenarios, two provided by the Fed and two defined by the bank.
All start in the fourth quarter of this year and go through the last quarter of 2014, taking into account loan-loss reserves at the end of 2013. Each Fed scenario for the U.S. variables includes five measures of economic activity and prices, four aggregate measures of asset prices or financial conditions and four measures of interest rates. The six largest banks will also have their trading portfolios tested against a “global market shock,” the Fed said.
The Comprehensive Capital Analysis and Review has become a centerpiece of the U.S. central bank’s heightened oversight of the largest banks. It is also an exam of decision making by bank management and boards. The Fed is assessing how well they understand their risks and demands on earnings and capital from new standards coming from both international accords and the Dodd-Frank act in the U.S.
“The aim of the annual capital plans, which build on the CCAR conducted earlier this year, is to ensure that institutions have robust, forward-looking capital planning processes that account for their unique risks, and to help ensure that institutions have sufficient capital to continue operations throughout times of economic and financial stress,” the Fed said in a statement.
The decision to make the scenario public before the tests began marks a step toward greater transparency in supervision by the Fed. The central bank didn’t disclose the scenarios when it started its 2011 stress tests in November last year. The Fed completed those tests in March.
The Fed will also publish the results of the tests for the 19 largest bank holding companies. Six institutions with large trading operations will have to estimate potential losses from a hypothetical “global market shock,” the Fed said. That shock will be based on market price movements seen during the second quarter of 2008, the Fed said, and include a scenario involving “sharp market price movements in European sovereign and financial sectors.”
The Fed said it would publish the results of the market shock scenario of the six institutions.
Bloomberg.com
Asian stocks down after US cuts 3Q growth estimate
BANGKOK (AP) -- Asian stocks fell Wednesday after the U.S. lowered its economic growth estimate for the third quarter and climbing yields on Spanish bonds magnified worries over Europe's debt load.
Hong Kong's Hang Seng fell 2 percent to 17,882.10. South Korea's Kospi lost 2 percent to 1,789.83 and Australia's S&P/ASX 200 shed 1.6 percent to 4,066.80. Japanese stock markets were closed for a public holiday.
Wall Street slipped Tuesday after a government report showed the U.S. economy grew at a 2 percent annual rate from July through September, down from an initial estimate of 2.5 percent. Economists had expected the figure to remain the same.
The Dow Jones industrial average lost 0.5 percent to close at 11,493.72. The Standard & Poor's 500 fell 0.4 percent to 1,188.04. The Nasdaq composite fell 0.1 percent to 2,521.28.
Higher borrowing costs for Spain, meanwhile, renewed worries about Europe's debt crisis. The higher rates suggest that investors are still skeptical that the country will get its budget under control despite a new government coming to power this week.
Investors have been worried that Spain could become the next country to need financial support from its European neighbors if its borrowing rates climb to unsustainable levels.
Greece was forced to seek relief from its lenders after its long-term borrowing rates rose above 7 percent. The rate on Spain's own benchmark 10-year bond is dangerously close to that level, 6.58 percent.
Underscoring jitters was the lack of market reaction to an announcement by the International Monetary Fund that it will provide quick cash on flexible terms to countries facing sudden financial stress.
"Failure of this news to result in significant gains across markets shows just how cautious investors are," Stan Shamu of IG Markets in Melbourne said in a report.
Concerns remain that Europe's debt crisis is pushing the region toward recession, which would slow industrial activity in countries around the world that export to Europe.
Australian resource shares took a big hit after the country's House of Representatives approved a proposal to impose a windfall profits tax on big mining companies. The Senate is expected to endorse the measure in early 2012.
BHP Billiton, the world's largest mining company, fell 2.6 percent. Rival Rio Tinto lost 1.6 percent and Energy Resources of Australia slid 4.2 percent.
Benchmark oil for January delivery was down 65 cents to $97.36 per barrel in electronic trading on the New York Mercantile Exchange. The contract rose $1.09 to finish at $98.01 per barrel on the Nymex on Tuesday.
In currencies, the euro fell to $1.3466 from $1.3509 late Tuesday in New York. The dollar rose slightly to 76.99 yen from 76.97 yen.
France’s AAA Status in Tatters as Yields Surge: Euro Credit
The extra yield demanded to lend to AAA rated France for 10 years was 158 basis points more than the German rate at 11:51 a.m. today. The gap was 200 basis points on Nov. 17, the widest spread since 1990, up from 28 in April. The French 10-year yield was at 3.5 percent, about midway between top-rated Holland and Belgium, which is graded one level lower at Aa1 by Moody’s. French borrowing costs are more than a percentage point above the AAA rated U.K.
“France isn’t trading like a AAA,” said Bill Blain, a strategist at Newedge Group in London, who recommends buying U.K. government debt. “The market has made its judgment already.”
The debt crisis that began more than two years ago in Greece and snared Ireland, Portugal, Italy and Spain is close to reaching France. Moody’s said in a report published yesterday that any persistent increase in borrowing costs would amplify the French government’s challenges as economic growth slows.
President Nicolas Sarkozy has unveiled two sets of budget cuts since August to preserve the credit rating and try to calm jittery markets. Two-year yields on French debt have climbed 55 basis points since Aug. 31 to 1.67 percent, while the rate on German notes of similar maturity fell 30 points to 0.42 percent.
“The market is concerned about the dissolution of the euro itself, hence only bunds are acting as a safe haven,” said Richard McGuire, a fixed-income strategist at Rabo Bank International in London. Germany is the region’s largest nation.
Credit Suisse
French 10-year bond yields may climb above 5 percent, analysts at Credit Suisse Group AG said in a note to investors yesterday. Euro leaders must reach “a momentous deal” for fiscal and political union by mid-January to save the 17-nation bloc, Credit Suisse said in the report.
Yield spreads have widened for the other AAA rated euro- zone countries -- Austria, Finland, the Netherlands and Luxembourg -- bringing the crisis from the periphery to the so- called core.
France has the biggest debt burden of the top-rated euro nations, at 85 percent of gross domestic product. Its financial institutions also have the largest debt holdings in the five crisis-hit countries, at 681 billion euros ($921 billion) as of June, according to data from the Bank for International Settlements in Basel.
“France is not a AAA at all,” said Nicola Marinelli, who oversees $150 million at Glendevon King Asset Management in London. “French banks are very exposed to euro-zone periphery. If they were to mark to market these loans at current levels, there would be huge losses.”
Weak Metrics
Moody’s and S&P currently have a stable outlook on French credit, though both have signaled the nation’s rating is at risk. Moody’s said Oct. 17 that France’s debt metrics “are now among the weakest” in the AAA club. France might be downgraded in a stressed economic scenario, S&P said four days later.
The prospect of France taking on additional liabilities to support countries such as Greece and Italy is among the main threats to its rating, according to New York-based Moody’s.
S&P roiled global markets on Nov. 10 when it sent and then corrected an erroneous message to subscribers suggesting France had been downgraded.
France says to resolve the region’s crisis the European Central Bank needs to be the lender of last resort, supporting Europe’s rescue fund. The French proposal, which would allow the ECB to fund purchases of troubled sovereign debt, has the support of leaders such as U.K. Prime Minister David Cameron.
German Opposition
Germany and the ECB oppose the plan.
“We don’t have any new bazooka to pull out of the bag,” Michael Meister, a senior lawmaker in German Chancellor Angela Merkel’s coalition, said in a telephone interview in Berlin today, reiterating opposition to the ECB plan.
The stalemate has added to market perception that France, the second-biggest backer of the European Financial Stability Facility after Germany, may get dragged further into a crisis that this month led to the ouster of Italian Prime Minister Silvio Berlusconi and Greece’s George Papandreou.
“Where are the guardians of the euro?” asked Eric Chaney, chief economist at Axa SA in Paris. “The EFSF, the ECB? The markets are going to continue to test them. Markets are increasingly betting on a breakup of the euro zone.”
European leaders agreed last month to boost the EFSF to 1 trillion euros to help contain the crisis. The fund owes its AAA rating to guarantees from the euro region’s six top-rated nations. The EFSF’s lending capacity would fall by 35 percent if France is downgraded, Mizuho Corporate Bank Ltd. analysts said.
French Vote
Sarkozy, 56, who faces a presidential election in April or May, and his government have vowed to do everything to defend France’s creditworthiness. They point to a reserve in the country’s 2012 budget to compensate for any economic slump, and this month unveiled 18.6 billion euros in tax increases and spending cuts to defend the rating. They’ve pledged to do more if necessary to reduce the deficit to 4.5 percent of GDP next year and 3 percent in 2013, from 5.7 percent this year.
“France has shown its seriousness on the budget, we’ve adapted,” Finance Minister Francois Baroin said today on France 2 radio. “We’re borrowing at the best rates in the past decade and we’re watching the situation closely.”
The current 3.5 percent yield on 10-year bonds compares with an average 3.9 percent during the past decade. The French treasury completed its funding requirement for 2011 when it sold 7 billion euros of medium-term debt and 1.1 billion euros of indexed bonds on Nov. 17.
‘Self Fulfilling’
France’s medium and long-term funding costs had an average yield of 2.8 percent in 2011, the second lowest since the euro was created, according to Agence France Tresor, the country’s debt-management body. It was 2.5 percent in 2010.
The market has “taken on its own dynamic, with its own forecasts that are partly self fulfilling and very far from the any fundamental analysis,” Philippe Mills, the head of AFT, told journalists last week in Frankfurt.
With the election coming up, “it is by no means certain that the government will be able to implement the proposed fiscal tightening,” said Jennifer McKeown, an economist at Capital Economics in London. “The clear downside of France’s exposure to the euro zone’s south is that a failure to address the problems of Italy and the peripheral economies will have disastrous consequences.”
Europe Will Implode if ECB Doesn’t Act Soon: Bob Doll
"It's not a matter of economics and how many Euros it will take to solve the problem, it's 'Is there the political will to do it?'" says Bob Doll, the chief equity strategist at BlackRock. He believes the longer leaders in Germany and the European Central Bank wait, the harder and more costly the ultimate fix will be. Along those lines, he thinks the ECB, and its new chief, need to do a lot of things and do them now.
"It's a bunch of things that need to be tried," Doll says in the attached video clip. "Back in late 2008, early 2009, Congress threw a bunch of things at the wall to see what would stick. I think that's what we are going to go through here."
Ultimately he'd like to see the ECB increase purchases of sovereign bonds, expand its balance sheet and lower interest rates further. And the pain of recession and market forces will force Europe's hand. Doll believes if markets and rates don't begin to normalize, a re-visitation of the hard fought 50% reduction in Greek debt (known as the 'haircut') might happen.
Interestingly, Doll was unmoved by recent headlines about China's warning on a global slowdown, saying it "wasn't anything we don't already know, they just verbalized it."
In the meantime, this strategist with over a trillion dollars under his purview, 60% of which is in domestic stocks, is in no mood to take a lot of risk. " You're better off in safe havens," says Doll.
Yahoo Finance
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