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Stock Buybacks: A Good Thing Or Slipped DISCs?


Does management act on behalf of shareholders? Do CEOs know what they're doing?


When a company announces share buybacks, is that a sign that good things are coming? Does management really know what it is doing? Do analysts following those CEOs know what they are doing? If a guy is a CEO he must know what he is doing, right?

Let's explore those questions starting with a February press release from Ambac (ABK), followed by set of emails I received last weekend from a contact at Morgan Stanley (MS). The emails are about stock buybacks and internal research at Morgan Stanley related to Ambac.

Here is the press release from Ambac:

Feb. 12, 2007--Ambac Financial Group, Inc. today announced the closing of 6.15% $400 mln Directly-Issued Subordinated Capital Securities (DISCS(SM)). The DISCs were sold at a discount to par to yield 6.199%. Ambac will use all of the net proceeds from the offering and additional funds to purchase $400 mln worth of shares of its common stock. The common stock will be purchased through an accelerated share repurchase agreement.

Morgan Stanley Comments, February 2007

Ambac Financial announced to AMC that they have closed on a $400 mln offering of Directly-Issued Subordinated Capital Securities (DISCs). This is a positive surprise since most investors did not expect/see any meaningful share repurchases in 1Q06 or 4Q06.

Ken Zerbe is increasing his price target following his recent meeting with the CEO of ABK. Ken felt the meeting was positive and provided him with greater confidence in the long-term story of ABK. His price target increases from $98 to $100 and EPS estimates remain above the street at 2007 $7.97 and 2008 $8.78.

My contact at Morgan Stanley, who for obvious reasons wishes to remain anonymous, made the following sarcastic comments at the time of the stock buyback announcement.

Ambac Financial, a New York-based insurance and financial services company, has just issued $400 million worth of new debt in complex hybrid debt notes, so-called Directly-Issued Subordinated Capital Securities (DISCs). …

Why issue 400 mln worth of debt to buy 400 mln worth of stock, when one can issue 800 mln worth of debt to buy 800 mln worth of stock? Another question for another time would be: if the company generates so much extra cash flow to pay the very substantial cost of this transaction plus the very substantial interest on the debt, why not just buy the stock in the open market with its own cash?

Think about the complexity of the deal; think about the work that has been done by lawyers, underwriters, analysts, brokers, compliance people, technology professionals, etc. All of them need to be paid. Think about the very complex nature of this debt, which will be sitting in someone's books as an asset; think about all the even more complex derivatives that will be, without question, created based on this debt.

Heck, we should all be grateful to ABK: This deal, as absurd as it is, has done its small part to maintain all this complexity for another 15 minutes.

Inquiring minds are wondering what the CEO and former CEO (current director) were doing with their own money shortly after the buyback announcement.

Director (Former CEO) Phillip B. Lassiter Dumps Shares

Click here to enlarge.

Current CEO Robert Genader Dumps Shares

Click here to enlarge.

Click here for all Ambac insider transactions over the last two years.

Ambac (ABK) Daily Chart

Click here to enlarge.

Flashback August 16, 2007

Morgan Stanley cuts Ambac target on possible CDO losses:

The brokerage, which has an "overweight" rating on Ambac, cut its price target on the stock to $92 from $100 and said Ambac could face losses of $1.3 bln to $5.0 bln. Analyst Ken Zerbe said he was building in a subprime/CDO loss expectation of $1.8 bln pretax, which he assumed the company will take beginning in 2008 through 2011.

Let's Do the Math

At current share prices Ambac has lost $200 mln+- on share buybacks, not counting interest on the debt and transaction fees.

Meanwhile, former CEO Phillip B. Lassiter somehow had the foresight to dump $10.37 mln worth of shares that would now be worth $5.18 mln+-. In addition, current CEO Robert Genader had the foresight to dump $10.20 mln worth of shares that would now be worth $5.00 mln+-.

Clearly these guys are worth the big bucks because they alone know how to make these kinds of mission critical decisions.

Non-Performance Rewarded

Professor David Nelson is asking Does Executive Compensation Pass the Smell Test?

Page after page has been written about Merrill Lynch (MER), the $8 bln loss and the failure of risk managers at not just Merrill but many of the U.S.' top financial institutions. When Robert Nardelli was ousted as Chairman and Chief Executive of Home Depot (HD) he received over $200 mln in severance compensation. Now we find that Stan O'Neil, the controversial and soon to be ex-CEO of Merrill Lynch, would have received over $200 mln if there was a change of control at Mother Merrill.

With the company reeling from recent financial losses and the stock down significantly how does a shareholder maintain confidence that management is working on their behalf?

Forgive me for being so cynical, but why should anyone think management is acting on behalf of shareholders? Time and time again, history has proven otherwise. Insider greed has never been greater.

What do we have to show for it?

  • Overbuilding of houses by homebuilders (Toll Brothers (TOL), WCI Communities (WCI), Pulte Homes (PHM), Dominion Homes (DHOM), Centex (CTX), etc).
  • A "Dancing Price", SIV problems, and Enron Accounting at Citigroup (C).
  • Banking problems everywhere related to mortgages.
  • Two Bears Stearns (BSC) hedge funds go to zero.
  • Enormous shareholder dilution in the number of options granted to insiders at Google (GOOG), Broadcom (BRCM) and, for that matter, many tech companies.
  • Countrywide (CFC) CEO Mozilo cashes out $1 bln worth of stock while running the company into the ground.
  • Earnings are "managed" to beat the Street by a penny practically everywhere even if it means holding assets off the balance sheet, stuffing the channel with merchandise, playing games with pension assumptions, stretching to the limit accounting practices, etc.
  • Insiders have been bailing like mad, and in some instances borrowing money to do so.
  • Dividends are in the sewer.

If corporations want to align themselves with shareholders there are numerous things they can do. Here are four of them.

1) Increase dividends.
2) Stop managing earnings.
3) Reduce executive compensation.
4) Reduce option expenses.

Imagine there was one major homebuilder that instead of buying more and more land at ever increasing prices was instead paying huge dividends for the past five years. Who would be ahead of the game now? The answer should be clear: both the corporation and the shareholder. Arguably the CEO would be behind because of stock options.

Stock options encourage excessive risk taking to the point of ridiculousness. But when the inevitable collapse comes, the CEOs don't care, as they have all cashed out hundreds of millions. In the case of Countrywide, over a billion dollars. It's sad to say, but in many corporations shares were repurchased with borrowed money even as insiders were bailing.

Question: With a company reeling from recent financial losses and the stock down significantly, how does a shareholder maintain confidence that management is working on their behalf?

Answer: One can't. If you start with that assumption you will be far better off.

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