Accelerated Stock Repurchase Programs: Underreported and Overpriced? Part II (Hewlett-Packard Addendum)

Abstract

The current study adds consideration of a $1.7 billion accelerated stock repurchase (ASR) by Hewlett-Packard (HP) to a recent analysis of 2006-2007 ASRs by Applied Materials, Cypress Semiconductor, Linear Technology, and Xilinx. The HP addition to company case studies leaves fundamental findings on ASRs unchanged including: 1) Liability (ASRs are denied a 10b-18 safe harbor) 2) Disturbing, pre-deal, stock activity (prices rise 10% pre-deal) 3) Idiosyncratic, incomplete, and sometimes misleading disclosures 4) Inferior risk/reward relative to alternatives. Studied ASRs all share these drawbacks. That does not prevent some from being profitable. Profitability depends on post deal stock performance rather than liability exposure, governance quality, or disclosure transparency. Still, regardless of profitability, ASRs are found to provide lower returns compared to simpler and/or less risky alternatives. So, why have ASRs grown in popularity in recent years? Other than sympathetic accounting, no satisfactory explanation is found or hypothesized. HP's ASR reinforces the view that cosmetic accounting rather than economics attracts companies to ASRs. In published interviews, HP managers explain their goal: A deal to smoothly offset anticipated options dilution without incurring a reported profit, loss or fee. HP's ASR achieves that goal. Like other ASRs, HP's requires no income statement recognition. Absent any income accounting, HP's banker and counterparty, BNP Paribas, is free to report that HP "probably saved over $100 million." However, we calculate, to the contrary, that the $1.7 billion transaction costs HP and its ongoing shareholders at least $115 million (6.7%) while exposing HP to unnecessary liability. Whether ASRs facilitate efficient execution of large buybacks with superior governance may be an open question. Arguably, equity accounting for options and buybacks should be revisited. But, as ASRs become a larger proportion of total buybacks, the need for better disclosure seems a modest, reasonable and necessary start.