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Zynga's board recently announced their authorization of repurchasing up to $200M shares of Class A stock. What are the implications when a company repurchases their own stock?

Some specific questions:

  • Does this mean the stock price will increase?
  • Can they repurchase at any price and any time?
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5 Answers 5

Ignoring taxes, a share repurchase has exactly the same effect on the company and the shareholders' wealth as a cash dividend.

In either case, the company is disbursing cash to its shareholders; in the former, in exchange for shares which shareholders happen to be selling on the market at the time; in the latter, equally to all shareholders.

For those shareholders who do not happen to be selling their shares, a share repurchase by a company is equivalent to a shareholder's reinvestment of a cash dividend in additional shares of the same company. The only difference is the total number of shares left outstanding. Your shares after a share buyback represent ownership of a greater fraction of the company, since in effect the company is buying out other shareholders on your behalf.

Theoretically, a share buyback leaves the price of the stock unchanged, whereas a cash dividend tends to reduce the price of the stock by exactly the amount of the dividend, (notwithstanding underlying earnings.) This is because a share buyback concentrates your ownership in the company, but at the same time, the company as a whole is devalued by the exact amount of cash disbursed to buy back shares.

Taxwise, a share buyback generally allows you to treat your share of the company's profits as capital gains---and quite possibly defer taxes on it as long as you own the stock. You usually have to pay taxes on dividends at the time they are paid. However, dividends are sometimes seen as instilling discipline in management, because it's a very public and obvious sign of distress for a company to cut its dividend, whereas a share repurchase plan can often be quietly withdrawn without drawing that much attention.

A third alternative to a dividend or a share repurchase is for the company to find profitable projects to reinvest its earnings in, and attempt to grow the company as a whole (in the hopes of even greater earnings in the future) rather than distribute current earnings back to shareholders. (A company may alse use its earnings to pay down or repurchase debt, as well.)

As to your second question, the SEC has certain rules that regulate the timing and price of share repurchases on the open market.

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a cash dividend tends to reduce the price of the stock by exactly the amount of the dividend - I am not sure where this comes from. Do you have any evidence to support this? There are companies like Caterpillar that pay quarterly dividends and there is no significant dip post dividend. –  user4127 Oct 25 '12 at 14:22
    
The company simply has that much less cash in the bank immediately after paying the dividend. For you as an investor, ex-dividend day is the first day you are not entitled to that particular dividend if you should buy the stock, so you should expect the price to be that much less. CAT's quarterly dividend may not be sufficient for the associated drop in price to be noticed among the random day-to-day variations in stock price. –  justin-- Oct 25 '12 at 15:41
    
I would expect a .50 cent drop per share in price of the stock immediately after that last dividend if your theory is correct. But it does not ever happen in fact there was an increase for a few days after the dividend was paid. google.com/finance?client=ob&q=NYSE:CAT –  user4127 Oct 25 '12 at 15:58
    
If that were to be the case every time, you could profit almost risklessly by buying the stock the day before ex-dividend, selling it the next day, and collecting the dividend. On average, though, you are not going to collect 90 days' worth of profits by owning the stock for one day. –  justin-- Oct 26 '12 at 2:02
    
the dividends are announced (at least in the case of CAT) ahead of time with a date of ownership of the stock... IE today it would be anounced .50 per share for every stock owner as of 15-oct-2012 will be paid 1-NOV-2012. If you look at the price you do not get the dips and spikes you say happen following dividends.... if you will look you can even see that the dates are fairly consistent so investors know that cat will be paying dividends and approximately what day. –  user4127 Oct 26 '12 at 12:42

A board authorizes the repurchase of shares because they feel the stock in undervalued. The hope is that the stocks will rise either directly by their repurchase, or in the near term due to the realization that the company is in better shape then the market thought.

Eventually those shares will be resold back into the market thus bring in more cash at a later date.

They will set limits on them maximum they will pay, they will also spread the repurchases out over a time period so they don't overwhelm the market.

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The future shares will be fewer in number, yet have claim to less cash in the bank. All in all, there's little reason the shares would rise in value.

Say there are 1M shares, trading at $10. Market cap is $10M of course. Now, there happens to be $2M cash in the bank so each share had about $2 cash. By taking the $2M and buying 200K shares, 800K shares remain, but why would you think they'd be valued at $12.50? The same $10 value per share is now an $8M market cap as $2M has been disbursed, no less so than if it were given out in a dividend.

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Stock is not bought for current value but rather for future potential value. So future value is the same(in theory) but the number of shares splitting that value is reduced. –  user4127 Oct 25 '12 at 19:14

the implications are that the company's earnings per share may seem greater, (after the company buys them there will be less shares outstanding), giving wall street the impression that there is more growth potential than there really is.

its an accounting gimmick that can work for a few quarters while the company evaluates how else to impress wall street

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A stock buy back reduces the number of stocks available on the open market. Since stocks are literally a share in ownership a buy back of the stock then when the company repurchases it has the effect of increasing the percent of ownership of the company of each stock.

Zynga has a Market Cap of ~1810M so a 200M buy back will increase the ownership value of each stock by ~12%. This has had the effect of an immediate stock price bump of around 12% which is to be expected as the value becomes the expected post buyback value.

However long term gains will require Zynga to turn around their business. This bump will only be sustainable if they can. If their business continues to decline then its stock price will continue to slide. There are some who would rather see Zynga invest that 200m in getting a new product to market to bring revenues up rather than spending precious capital on a plan to temporarily bump a stock that is headed towards the floor. If on the other hand the revenue is poised to recover and the company has the excess capitol buying back stock low is a great way to get the most back for your shareholders bucks.

Can they repurchase at any price and any time?

They can write a buy order for any price at any time in the future, though they have some restrictions from the SEC mostly involving disclosures. But it is up to the sellers to choose to sell at that price. If they execute the buy back at a rate comparable to market rate then they are more likely to get takers than if they attempt to buy it back at a significant reduction from market price.

So since today(10-25-2012) the it is selling for ~2.30 A buy order for 2.30 is going to get more action than one at 2.00. Investors will often look at the companies buy back offer for a company in decline(like Zynga has been) as the true value of the company. If so then a lowball buyback offer could add downward pressure on the stock price.

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Chad, if this is the effect, they why wouldn't and cash rich company use the cash to do this? I'd love to see an historical study of this phenomenon, but my gut says that those shares are no higher I value as they now have less money in the bank. –  JoeTaxpayer Oct 25 '12 at 18:38
    
@JoeTaxpayer - From the answer There are some who would rather see Zynga invest that 200m in getting a new product to market to bring revenues up rather than spending precious capital on a plan to temporarily bump a stock that is headed towards the floor. As an investor I would want to see that... as someone who is really tired of seeing Zynga games posts on my facebook I like their idea to piddle away their reserves :p –  user4127 Oct 25 '12 at 18:41
    
@JoeTaxpayer - The only major company I recall using this tactic successfully would be Microsoft. ~2007 MS was sliding down for no apparant reason(good revenue, cash, though growth had stagnated). They announced a stock buyback and it stopped the slide... that or the stock was going to rebound anyway and the timing was coincidental but I do not really believe in coincidence here. –  user4127 Oct 25 '12 at 18:44
    
there are a number of ways to look at this, but I believe that in the same way a stock split or reverse split doesn't change true value, I don't believe buy backs create money/value from nothing. –  JoeTaxpayer Oct 25 '12 at 21:14
    
@JoeTaxpayer - I agree and basically said the same. But stock price is not about real value or we never would have had the .com bubble. –  user4127 Oct 26 '12 at 12:34

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