It’s not always a good thing when firms buy back their own shares. For example, under the pretense of creating value for shareholders, managements could use owner funds to increase the value of their stock options. But on the opposite end of the spectrum, there are also cases where buybacks have the potential to create enormous value for long-term shareholders.
Consider a company that breaks even that trades for $50 million and has cash of $100 million. It could pay out all its cash, resulting in an approximate 100% gain for existing shareholders. Or, it could nibble away at its shares. Consider an extreme case where the company spends $25 million buying back shares and the share price doesn’t budge: the company would then trade for $25 million, but still have $75 million in cash; a cash distribution would now result in a 200% gain for the shareholders who stuck around! Value has been augmented for shareholders who hung on by transferring the value potential of those who sold early to those who stayed.
Now consider Quest Capital (QCC), a company we have previously discussed as a potential value investment. While it is not in the exact same enviable position as the hypothetical company described above, it does share some common traits that make it attractive as a “buyback target”.
For one thing, it trades at a deep discount to its net asset value. While those assets are unfortunately not cash, the company is in the process of monetizing them. Since the end of the last reporting date, the company has issued updates announcing that another $20 million of preferred stock has been bought back. This appears to be a signal that monetization of assets is going well, since the company did not have that kind of cash as of its latest report.
Most recently, the company has now announced it plans to buy back common shares, as soon as this week. In its history, this company has not been one to buy back stock. But this time around, the reasons to do so are clear, and the motivations appear to coincide with what we discussed:
The Corporation’s directors believe that normal course issuer bid purchases of shares for cancellation may, by reducing the number of outstanding shares, reduce the discount that may exist between the market price of its shares and the Corporation’s net asset value per share.
Stock buybacks are not just catalysts for prices to align with intrinsic values. They can also boost value for shareholders, by transferring the potential price appreciation of the shares of exiting shareholders to the shareholders that hold on.
Disclosure: Author has a long position in QCC
