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The unusual case of the cheaply valued share buyback

05/05/2017

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

In theory, companies should only buy back their shares on cheap valuations. In practice, this happens so rarely, it is well worth highlighting when it does.

The share buyback can be a beautiful thing – at least in theory. The idea is that a company buys back some of its own shares from existing investors and, because these are no longer publicly available, the market value of the shares that are still in issue should increase – at least in theory. And the reason we keep saying “in theory” is it does depend on the company buying back its shares at a suitably cheap valuation.

Unfortunately, as we observed in Morally neutral, history suggests corporate managers tend not to be the most natural of countercyclical investors, buying their own shares – not to mention whole other companies – when prices are too high and having share issues when prices are too low. All of which makes the current plans of California-based company Bridgepoint Education particularly interesting.

Bridgepoint is one of a number of for-profit businesses that run educational institutions in the US for people looking to gain extra skills and qualifications outside the usual channels. Some are successful operations while others have attracted some bad publicity for the sector – the now-defunct Trump University, which ran a real estate training programme between 2005 and 2010, being the most high-profile example.

The sector, which we touched on a few years back in Perverse psychology – also in the context of share buybacks – has traded on cheap valuations for some time even though a number of the businesses are financially strong, with healthy cash balances. That combination goes a long way to explaining why, here on The Value Perspective, we own several for-profit education companies across our portfolios, including Bridgepoint.

While it may be perfectly logical for companies to build up their reserves at times of uncertainty, investors can grow quite disgruntled when they believe a business is allowing its cash to sit around, apparently doing nothing. As a result, Bridgepoint has found itself under growing pressure to explain what it might do with its own cash balance – and in March it came out and said it would be embarking on a share buyback programme.

Not your run-of-the-mill buyback

This is not – in terms of size or structure – your run-of-the-mill buyback. For one thing, Bridgepoint has agreed to buy back 18 million shares – of the 46 million in issue – from its largest shareholder, the private equity company Warburg Pincus. It is doing so at a point where its shares are very heavily depressed in valuation terms. For about $150m (£117m) then, it is retiring 40% of all of its shares in issue.

Now, clearly there is more to this deal than what is in the public domain – after all, private equity firms do not make a habit of selling significant shareholdings on depressed valuations, just on a whim. It could be, for example, that Warburg Pincus is looking to create more liquidity in the market for Bridgepoint shares – in effect, make them easier to buy and sell – ahead of selling the remainder of its stake further down the line.

Here on The Value Perspective, we are not privy to the details of the deal so we do not know the explanation. What we do know, however, is while the theory runs a company should only buy back its own shares when it believes them to be cheaply valued, this happens so rarely in practice – and certainly not in such an extreme way – the Bridgepoint plan is well worth bringing to your attention. How it plays out could prove educational.

Author

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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