Emmis Communications and ITT Educational Services and Stock Market and Investing and Banking & Finance and WellPoint and Health Insurance and Health Care & Life Sciences and Health Care & Insurance

Firms' faith in stock buybacks not always well-placed

May 7, 2011

Stock buybacks often get a warm reception from shareholders. The appeal is obvious: When companies purchase their own shares on the open market, they leave holders of the remaining stock with a bigger slice of the ownership pie.

Investors in WellPoint Inc. and ITT Educational Services Inc. saw the benefits firsthand in the first quarter. Buybacks helped WellPoint report a 25-percent increase in per-share profit, far greater than the company’s 6-percent increase in overall profit.

ITT’s profit actually fell slightly in the first quarter. Yet the smaller number of shares outstanding boosted per-share profit 18 percent.

But as many executives who’ve been burned by buybacks can tell you, it’s premature to toast the WellPoint and ITT boards as savvy stewards of their companies’ capital. That’s because the ultimate test of whether buybacks are good deals for shareholders hinges on whether the price paid for the stock proves over time to have been a bargain or inflated.

Just ask Jeff Smulyan, chairman of Emmis Communications Corp., which in hindsight wildly overpaid in 2005 when it bought back 20.2 million shares for $395 million, or an average of $19.50 apiece.

Emmis shares now trade for only about a dollar (though part of the decline stems from a $4-a-share cash dividend the company issued four years ago).

Since the beginning of 2006, WellPoint has spent a whopping $21.8 billion on share repurchases, including $742 million in the latest quarter, a review of securities filings shows.

Some of those purchases look cheap, others expensive. In 2009, for instance, it spent $2.6 billion buying shares at an average price of $46.02 each—40 percent below the current price of around $77. On the other hand, in 2006, WellPoint spent $6.2 billion scarfing up shares at an average price of $80 each.

Overall, WellPoint has come out ahead on purchases since the start of 2006, when the buying spree began in earnest. The average per-share price paid in that span was $63.67.

But not everyone is impressed. In a Bloomberg article last fall, a pair of investment experts took WellPoint and competitor UnitedHealth Group Inc. to task for collectively plowing more than $51 billion into buybacks since 2004.

The buybacks have disappointed shareholders who consider dividends a better investment, Jeff Fahrenbruch, an analyst at Barrow Hanley Mewhinney & Strauss, told Bloomberg.

The strategy has been “a colossal misjudgment,” added Leon Cooperman, chairman of New York-based Omega Advisors Inc. “They’re saying they know with a high degree of confidence that this is the best choice for shareholders and they couldn’t be more wrong.”

WellPoint didn’t pay a dividend until this year, when it started doling out 25 cents per share each quarter—a commitment that will cost it nearly $400 million a year.

It’s one of a parade of U.S. firms trying to capitalize as jittery investors flock to firms that offer the security of regular dividends. WellPoint was one of 117 members of the S&P 500 index to initiate or increase dividends in the first quarter.

Investor enthusiasm for dividend-paying stocks is entirely warranted, thanks in part to the long-term compounding power of reinvested dividends, according to a new report from Atlanta-based Ridgeworth Investments. Reinvested dividends have accounted for nearly half the total return for stocks since the 1930s, Ridgeworth said.

But WellPoint’s decision to launch a dividend doesn’t mean it’s backing away from share buybacks. The company said in April that it expects to make an additional $882 million in share repurchases by the end of this year.

In fact, WellPoint in January could have paid off the entire balance on a chunk of debt that was coming due but opted not to because interest rates were so low and it didn’t want to tie up cash.

“We could deploy it to better uses such as buying our own shares,” Martin Miller, WellPoint’s chief accounting officer, said at an investor conference this month.

Vera Bradley founders cash in

Vera Bradley Inc. continues its storybook run as a public company, which is making founders Patricia Miller and Barbara Bradley Baekgaard very rich indeed.

The Fort Wayne-based company in October launched its initial public offering at $16 a share. The stock took off from there and now trades for more than $47, ballooning the company’s market value to $1.9 billion.

In conjunction with the IPO, Miller received $42 million in earnings distributions, and she and her husband together sold $45 million in shares. They unloaded another $110 million in stock in a secondary offering last month, but still own shares worth $340 million.

Baekgaard has fared just as spectacularly. She received $42 million in earnings distributions and cashed in stock worth $35 million in the IPO. She sold another $99 million in stock in the secondary offering while holding onto shares worth $414 million.•

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