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DBL%20Hendrix%20small.png College chemistry, 1983

Derek Lowe The 2002 Model

Dbl%20new%20portrait%20B%26W.png After 10 years of blogging. . .

Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases. To contact Derek email him directly: derekb.lowe@gmail.com Twitter: Dereklowe

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August 23, 2012

More on Pharma Stock Buybacks

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Posted by Derek

Bruce Booth has an excellent look at a topic we were discussing around here earlier this year: stock buybacks in biopharma. I didn't have a lot of good things to say about the concept. I understand that corporations have obligations to their shareholders, and I certainly understand that a stock buyback is about the least controversial thing a big company can do with its money. Paying shareholders through dividends has tax consequences. But you can't sit on a big pile of cash forever, and what are you supposed to do if you think that market returns will beat the return on investment in your own business?

That brings up another, larger question: if you truly believe that last part, how long do you think that situation will obtain? And how long are you willing to put up with it? If a business really, truly, can't deliver returns that could be realized through a reasonable investment strategy, then why is it in business to start with? (I've seen discussions among economists about this very point when applied to many small businesses).

Booth wonders about the use of capital, too:

In recent years, plowing it back into internal R&D hasn’t been the preferred option given pipeline productivity questions. Returning capital to shareholders via dividends has certainly been high on the list. Another, albeit indirect, way of paying shareholders is through share repurchases (stock buybacks), and it has also been quite popular. The expectation (or hope) with these indirect stock buybacks is that the stock will move upwards because the shares oustanding goes down (or at least the buybacks offset the dilution from the exercise of options).

But buybacks have a more mixed assessment in practice (links at his site - DBL) and are typically only a smart if a company is (a) under-valued and (b) has no better uses of capital. This latter point is where they draw my ire, especially given their scale in our industry and the many strategic alternatives.

Totaling up the buybacks gives you some humongous figures. One thing that I'm not quite sure about with these numbers is whether all these buybacks are actually followed through. You'd think there would be legal consequences if the discrepancy grosw too large, but I don't know the law on this topic. But taking the figures as we have them, you get this:

To appreciate the magnitude of these buybacks, it’s worth comparing them to other important financial values in the biopharma ecosystem. It’s bigger than the NIH budget for both 2011-2012 by nearly 25%. It’s 4.5x bigger than all of the private venture-backed M&A that occurred in the past 18 months – and that involved over 70 biotech companies. It’s 12x bigger than the sum total of venture dollars invested in biotech in that period. And it's nearly 80x bigger than all the capital raised by fifteen biotech IPOs during that period. This is a huge amount of capital washing into stock repurchases.

The problem is, as Booth goes on to show, is that there's no particular correlation (that anyone can see) between these buybacks and the performance of the stocks themselves. (You could always say that they'd have performed even worse without the buybacks, an unanswerable and untestable point). He's got some other suggestions for the money, and he's not even asking for all of it. Or half of it. Or a tenth. Five per cent of the buyback pool would totally alter the funding universe for early-stage companies and precompetitive consortia. In other words, potentially alter the future of the whole industry. But we're not doing that. We're buying our own shares. Tens of billions of dollars of our own shares, because we can't seem to think of anything better to do.

Comments (10) + TrackBacks (0) | Category: Business and Markets


COMMENTS

1. Anonymous on August 23, 2012 8:18 AM writes...

It might change the funding universe for early stage companies or pre-competitive consortia but to provide a better return, the 'right thing' would still have to be invested in.

Given Pharmas track record of buying anything pre PhIII and turning it into a successful drug (numbers anyone?) I doubt this is going to make investors happy.

Pre-competitive consortia - can we all agree about what is really going to change the landscape to make drug discovery more successful?? Won't this just favor the big guys who can follow up quickly??

Much as I hate what stock buy-backs say about our industry I haven't seen an obviously better solution. If we can't find drugs with the $BB we are spending, why would another few help?

Permalink to Comment

2. PharmaHeretic on August 23, 2012 9:53 AM writes...

Really.. Did you not spend two entire posts last week telling readers how only pharma "knows" how to do drug research and that we should "trust" them and their business model. Now you seem to say that they are either incompetent or conmen looking for a quick buck.

So what is it? Does pharma (as it exists today) have a good business model or are they conmen/charlatans out for money? Do they "know" what they are doing? Or are they faking competence?

Permalink to Comment

3. JackP on August 23, 2012 9:59 AM writes...

As an ex-Kodaker, I think their stock buyback program is an extreme example of this foolishness.

New York Times, October 18, 1995
"...said it would spend $1 billion to buy back 2.5 percent of its stock in the next six to nine months."
" ...price of Kodak's shares on the New York Stock Exchange up $2.50, to $59.625, a gain of nearly 4.4 percent."


Reuters, Tue Jun 24, 2008
"...said on Tuesday it would buy back up to $1 billion of its stock."
Stock price, about $14 at that time.


Current price, about $.22, and the company is in bankruptcy. Where would the company be if they had that $2B now? It sure didn't prop up the stock price.

It seems to me that if a company's leadership doesn't have enough vision to find a useful place to invest, they need to be replaced.

Permalink to Comment

4. simpl on August 23, 2012 10:38 AM writes...

Other arguments for buybacks include converting current cash flow into the future value, and increasing control of outstanding shares.
Like quantitative easing, it is not real money, so it does not carry the downside risk of a merger or buy-out.
The aim to maximise value has boundaries - otherwise they could buy shares in, say, tobacco companies or banks.

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5. Ben A on August 23, 2012 12:15 PM writes...

Key missing fact here is the debt market. Right now corp debt is cheap. So why not buy-back shares?

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6. Helical_Investor on August 23, 2012 12:43 PM writes...

I made my initial comments yesterday in the linked blog (Ralph Casale). To expand, not all buybacks are the same. Sometimes they are used (Apple recently) to offset stock compensation, and should therefore be considered more a compensation expense than a deployment of capital.

Of the big pharmas listed, JNJ was the one with the largest buyback commitment (>$14B). But $12.9 billion of that amount in the chart (at least) wasn't truly a traditional buyback, but more financial engineering to use ex-US cash for the Synthes acquisition (issue stock for the acquisition, buy it back overseas). I commented on it here.

http://beta.fool.com/tmfhelical/2012/06/14/x-file-johnson-johnson-completes-merger-synthes/5797/

Overall, I liked his post and points. But with share buybacks, rarely are things so black and white (like they are with dividends).

Zz

Permalink to Comment

7. watcher on August 23, 2012 12:48 PM writes...

Seems to me that's it's very hard to know if stock buy-backs have much positive influence on stock price as there's never a control situation where the same stock within the same market conditions does not do the buy-back. Even so, I see no reason that this money be randomly provided to support biotech or early academic derived ideas. There already is a lot spent in this arena, and we know of the results as often discussed in this blog. Why would more money somewhat randomly thrown at potential problems, some of which would go to pay "management overhead", give better results? I'd prefer that companies give back such money through supplementary dividend distributions, which would be an appropriate visible reward to existing stockholders for their belief in having owned the stock in the first place.

Permalink to Comment

8. Helical_Investor on August 23, 2012 1:55 PM writes...

#7 I do not agree that there is no way to evaluate the influence of a buyback on share price. On any given day, a stock trades at very public price-per ratios (earnings, sales, book value, etc.). These can each be evaluated for 'before and after'. If someone is willing to pay 12.5X earnings for Pfizer today, it can indeed be extrapolated what the share price would be if more shares were outstanding.

Similarly, an annual return can be calculated regarding the buyback. If a buyback was done 3 years ago at $46, and the shares today are $62, then an annual return is easily calculated. What is not so clear is what to compare this return to? Is this a use of assets (cash) and thus compared to a historical return on assets, of equity and thus compared to a historical ROE, or should this be better compared to the ROIC, WACC or other accounting acronyms. Should industry averages or company specific values be used?[I would not mind hearing opinions if posters truly have them]. not simple.

Zz

Permalink to Comment

9. Anonymous on August 23, 2012 3:34 PM writes...

8. Helical_Investor: "....What is not so clear is what to compare this return to? Is this a use of assets (cash) and thus compared to a historical return on assets, of equity and thus compared to a historical ROE, or should this be better compared to the ROIC, WACC or other accounting acronyms. Should industry averages or company specific values be used?[I would not mind hearing opinions if posters truly have them]. not simple."

Thank you for helping make my point. How does one tell if the buy-back has actually achieved anything above and beyond what the market would have done without it? What do you compare it to? How do you know what the shares whould have been without the buy-back? $60 with more shares still outstanding? $62 anyway? Like I said, no control conducted!

Permalink to Comment

10. watcher on August 23, 2012 3:35 PM writes...

8. Helical_Investor: "....What is not so clear is what to compare this return to? Is this a use of assets (cash) and thus compared to a historical return on assets, of equity and thus compared to a historical ROE, or should this be better compared to the ROIC, WACC or other accounting acronyms. Should industry averages or company specific values be used?[I would not mind hearing opinions if posters truly have them]. not simple."

Thank you for helping make my point. How does one tell if the buy-back has actually achieved anything above and beyond what the market would have done without it? What do you compare it to? How do you know what the shares whould have been without the buy-back? $60 with more shares still outstanding? $62 anyway? Like I said, no control conducted!

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