What Is a Leveraged Buyback?

A leveraged buyback is a corporate finance transaction that enables a company to repurchase some of its shares using debt—reducing the number of shares outstanding increases the remaining owners' respective shares.

Also known as a leveraged share repurchase, a leveraged buyback has similar impacts as 澳洲幸运5官方开奖结果体彩网:leveraged recapitalizations and 澳洲幸运5官方开奖结果体彩网:dividend 澳洲幸运5官方开奖结果体彩网:recapitalizations, in which companies employ leverage to pay a oꦦne-time dividend. The difference is that dividend recapitalizations do not change the ෴ownership structure.

How a Leveraged Buyback Works

Leveraged buybacks should have no immediate impact on a company's share price, net of any tax benefits from the new capital structure, and higher interest payments. The extra debt provides an incentive for management to be more disciplined and improve operational efficiency through cost-cutting and downsizing, to meet larger interest and 澳洲幸运5官方开奖结果体彩网:principal payments. This justifies any extreme levels of debt in 澳洲幸运5官方开奖结果体彩网:leveraged buyouts.

Leveraged buybacks are sometimes used by companies with excess cash to de-capitalize their balance sheets and avoid 澳洲幸运5官方开奖结果体彩网:overcapitalization. Increasing the debt on the balance sheet can provide 澳洲幸运5官方开奖结果体彩网:shark-repellant protection from 澳洲幸运5官方开奖结果体彩网:hostile takeovers.

Like other share repurchases, leveraged buyouts are often simply used to increase differentꦫ company metrics, such as:

• 澳洲幸运5官方开奖结果体彩网:Earnings per share (EPS)
• 澳洲幸运5官方开奖结果体彩网:Return on equity (ROE)
• 澳洲幸运5官方开奖结果体彩网:Price-to-book (P/E) ratio

Leveraged Buybacks and EPS

Boosting EPS through leveraged buybacks can be an effective tool for companies to use, but it does not signify an improvement in underlying performance or value. It can even do damage to the busin⛎ess if financial engineering comes at the expense ꦗof not investing capital productively for the long term.

Executives say there are not enough investment opportunities. But, there is a big conflict of interest, given that executive compensation is linked to EPS in �🐭�most American companies.

Financial markets have rewarded companies using buybacks as a substitute for improving operational performance. So it is no wonder that buybacks became one of 澳洲幸运5官方开奖结果体彩网:Wall Street's favorite tools since the global 澳洲幸运5官方开奖结果体彩网:financial crisis.

Between 2008 and 2018, companies in the United States spent over $5 trillion buying back their stock—over half their profits. And for large companies like Procter & Gamble, Mondelez, and Eli Lilly, approximately 40% of EPS growth has been a result of buybacks.

Leveraged Buyback Returns

In 2017, leveraged buybacks were reported to have made a big comeback in the U.S., where share repurchases have exceeded free cash flow since 2014. They were also used to avoid having to repatriate cash and pay U.S. taxes.

The buyback boom increased the risk for both bondholders and shareholders. Even investment-grade companies were willing to sacrifice their credit ratings in order to reduce the number of shares. For example, McDonald’s, whose executives depend on EPS metrics as a component of their performance incentive payout, had borrowed so heavily to fund buybacks that its credit rating fell from A to BBB between 2016 and 2018.

Rising interest rates can impact leveraged buybacks. But so could politicians. The 澳洲幸运5官方开奖结果体彩网:Inflation Reduction Act of 2022, which was signed into law by former President Joe Biden on Aug. 16, 2022, includes an 澳洲幸运5官方开奖结果体彩网:excise tax of 1% on share buybacks that exceed $1 million after Dec. 31, 2022.

Senate Democrats strongly criticized the buyback boom, arguing that 澳洲幸运5官方开奖结果体彩网:Trump's tax reform didn't trickle down to workers. They wanted to regulate buybacks, which were seen as a form of market manipulation before the 澳洲幸运5官方开奖结果体彩网:Securities and𒀰 Exchange Commission (SEC🍸) gave them the green light in 1982 when it adopted 澳洲幸运5官方开奖结果体彩网:Rule 10b-18. That protected corporations from charges of stock market manipulation if buybacks on any given day were no more than 25% of the previous four weeks’ average daily trading volume.

Biden 2023 State of the Union Address

In his State of the Union address in February 2023, former President Biden said he would propose quadrupling the tax on corporate stock buybacks. It was not clear from his statements whether such a proposal would also impact leveraged buybacks. Further, analysts like former Evercore ISI strategist Tobin Marcus suggested that the likelihood of the passage of a buyback tax was low. Still, investors may keep future buyback-related legislation in mind when developing strategies.

Biden's announcement, which was never realized, followed a December 2021 push from SEC Commissioner Allison Herren Lee in support of corporate share repurchase policies enhancing transparency "by requiring more detailed, timely, and structured disclosures" of buybacks.

The Bottom Line

Leveraged buybacks are corporate finance transactions through which a company repurchases a quantity of its shares using debt. With added debt, many companies that complete a leveraged buyback also institute cost-cutting or downsizing measures. Leveraged repurchases are often used to increase a corporation's earnings per share by reducing the overall number of shares outstanding.

This does not fundamentally impact the company's underlying performance or value. This technique can also help to decapitalize a balance sheet. Buybacks in general have been a target of the Biden administration, first through a 1% excise tax in the Inflation Reduction Act of 2022 and more recently via comments the president made in the 2023 State of the Union address.