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ITT Educational Services Inc. Message Board

  • swingtrader76 swingtrader76 May 30, 2012 11:19 AM Flag

    The Folly of ESI's Buybacks

    I did some quick math and came up with some pretty interesting info on how wasteful ESI's buybacks have been to shareholder value.

    As of 3/31, ESI had 24.1 million shares outstanding and a market cap of $1.4 billion.

    Over the last 6 years they have bought back 24.6 million shares at an average price of $78 for a total cost of $1.9 billion. Had they just kept that cash on the balance sheet, they would have 48 million shares outstanding, but a cash per share of $40!

    Put another way, they have lost about $21 per share they have bought back ($78 (the average price they paid) - $57 (today's price)). Take this loss per share times the 24.6 million they have purchased and you are looking at a capital loss of $516 million!

    As long as they trade below $78, the buybacks will not have been accretive to shareholders' overall value versus keeping it on the balance sheet or paying it out in dividends.

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    • yep, they have been buying hig great stategey... Wait for the 40's to pull the trigger.

      • 2 Replies to dell4131
      • Dell, Let me ask you a some questions. I would appreciate your thoughts on these. What would have recommended ESI do over the past six years with its $1.6 billion of excess free cash flow? They used it to buyback shares, reducing the share count from 48 million to 25 million. Do you think they should have just let the cash accumulate on the balance sheet earning less than 1% in T-bills? Do you think that they should have paid out the $1.6 billion in dividends to stockholders? Do you think that they should have bought some other education companies? Maybe a combination of the above? I am curious as to what you would have proposed.

        At the time of the last quarterly conference call, ESI said that the had 2.8 million shares left in their prior stock buyback program and that the board of directors had increased this by another 5 million shares to 7.8 million. At that time ESI shares were at about $61. So the board is thinking that they have at present the visibility and the capacity to spend another $475 million on additional buybacks. ESI already has $293 million in cash on its balance sheet. This number has remained fairly constant, so I would not expect it to drop too much as a result of the buyback, so the board probably expects the buybacks to be funded from excess free cash flow. The $475 million in buyback authorization requires a total of $19 in per share earnings to execute ($475 million dividend by current 25 million shares outstanding). Well, ESI raised guidance to $8.50-$9.00 for 2012, and I expect the eps figures to be raised again (towards $10 per share)in the following quarters of 2012. That means that the board sees themselves as being halfway home on the enlarged buyback in 2012 alone. With share down to $55 now, ESI will be able to buyback shares at a rate faster than initially anticipated at the time it enlarged the buyback.

        Anyway, ESI shares have acted like dog meat lately, and after going up about 35% this year, are now down for the year. I do not expect the short sellers to give up their attacks on the company. The short interest is simply too large and entrenched for them to do anything but engage in a fight to the death. The ESI stock buybacks are only exacerbating the situation. Short covering simply seems like an impossible option and continuing to mount a negative campaign against the company has had traction with the stock price. This is an unfortunate negative for the shares as the news flow from other sources outside the company will have a negative bias. The bears on ESI have been waiting several years for a much anticipated collapse in earnings. There has already been a drop off in dollar profits at the company as enrollment numbers have declined. However, the magnitude of the company's cash flow has been such that it has reduced its share count such that the earnings per share has not fallen much at all. It seems like that stock price is in this limbo land where the valuation is incredibly low (a p/e of 5) and the buybacks incredibly huge, but the negative press continues. I was just thinking that the last time I saw something similar was in the tobacco sector. These companies produce products that kill people (and there is never any positive press for that sector), yet the cash flow characteristics are so positive that Altria shares trade at a p/e of 14 times and have a dividend yield of 5.4%. If ESI were to pay out its excess cash flow in dividends, the yield would be on the order of 10%.

      • Swing and wp, both bears on ESI, seem to operating at cross purposes. Swing says that ESI's share buybacks have destroyed shareholder value because they have been made at an average price greater than the current price. Then, WP posts in the thread saying "I wonder where ESI's share price would be without the buyback"...with the clear implication that with ESI buying its own stock, the share price would be alot lower.

        Swing is correct in that had ESI been able to pay $55 for its shares in buybacks that have taken place over the past six years, the shareholders would have been better off. ESI paid in the high $70's on average. However, it is not practical to think that ESI could have bought back all that stock at $55. It would not be possible. In any event, there are strict rules governing buybacks and how much stock can repurchased over time. As such, I believe that swing is comparing what happened in the buyback to an alternative outcome that is simply not something that could have ever happened in reality. Therefore I do not think that the comparison holds water. The proper comparison is what if ESI bought back no stock and then paid all the money out to shareholders in dividends. That would leave the shareholder with a pile of "after-tax" dividends and a stock price trading at a level based on earnings where the share count was much higher. That is the correct math to do.

        Regarding wp's comment, with all due respect. I do not think that he has thought through the issues fully or done any financial calculations to support one view or the other. He certainly made no attempt to calculate where he thought the ESI share price would be without the buybacks. Instead of wondering where the ESI share price would be, he could have made some effort to calculate where it should be.

        It is great to have some of this commentary on the board as it make the ESI chat board much more interesting and useful.

    • swing,

      Your numbers are correct that ESI has bought back $1.9 billion of stock over the past six years at an average price of $78. I have kept track of each quarter's buybacks for some time now. And so certainly one can say that at a current price of $57, ESI has overpaid by $20 per share for its stock.

      This analysis appears good on the surface but it is flawed, if you don't mind me saying so.

      1. Had ESI kept the $1.9 billion in cash and were it to then attempt to repurchase shares at the current price of $57, that $57 level would only be there for a nanosecond and the shares would climb so steeply that who can say what an ultimate comparable buyback price would be.

      2. Your $57 reference price happens to be the recent low. Shares only two months ago were mid $70's and at that time your analysis certainly would not hold. And shares are not down from $57 because the company missed an earnings number (earnings estimates were beaten and forward estimates raised). ESI shares can just as soon go right back up to $75, so picking just one point in time when the shares are down to $57 is just cherry picking a time and price that suits your purpose.

      3. Had ESI kept the $1.9 billion, eps would currently be $4.00 share. At the current p/e of 5, the shares would trade at $24 ($4 x 6) plus the value of the cash assuming it was paid out to shareholders as a dividend on an after tax basis ($1.9 billion less 15% federal div tax, forget about extra for state taxes). The cash is then worth $1.61 billion divided by 48 million shares, or $33.54 per share. The combined value is then $57.54. So why are shareholders worse off overall? The cash sits on the balance sheet earning nothing, doing shareholders no good.

      4. Your analysis fails to adjust for the 15% dividend tax, which basically completely offsets the impact of the current lower stock price against the buyback price that you make your measurement against.

      5. Stock buybacks are without question the most optimal use of the cash as the valuation of ESI is well below the market and as the valuation is depressed due to the current environment in the education sector. Buybacks totally avoid the 15% dividend tax. Cash sitting on the balance sheet in effect earns nothing. ESI as a business generates a free cash flow yield of $160 million against a market cap of $1.4 billion, or a yield of 11.4%. Go try to find a yield like that anywhere. Even paying $78 for the shares generates a free cash flow yield of 8.9%.

      The more interesting analysis is what is going to happen when ESI repurchases the next 10-15 million shares and the shares outstanding collapse to 8 - 13 million against a short interest of 9.8 million. Now that is something to ponder.

      • 2 Replies to oxledge
      • quote :1. Had ESI kept the $1.9 billion in cash and were it to then attempt to repurchase shares at the current price of $57, that $57 level would only be there for a nanosecond and the shares would climb so steeply that who can say what an ultimate comparable buyback price would be."

        I re-read this, and I realized you're basically making my point. If ESI had all of this cash on the balance sheet, they could buy at $57 and drive the price up. If it was only for a "nanosecond" and the price dropped back down, they could buy it up again. If instead, it STAYED higher, they could keep the unused cash on the balance sheet, wouldn't that be better for investors? Cash on the balance sheet acts as a floor.

        I'm not saying companies should be timing the market, but the board/management at ESI has had NO strategy with buybacks, they just keep buying it an any price (mostly too high), at the detrimate of long-term holders (i.e. you).

      • 1) I'm sure you were making the same arguments when the stock traded north of $100 that it was "without question the optimal" use of their cash to buyback shares because the shares were "undervalued."

        2) Of course my analysis was in retrospect based on current prices. What else are you going to use? Your assumption(prayer) that prices will rise 50% soon despite the fall off in enrollment/revenue/margins?

        3) Who marks down cash on the balance sheet on an after 15% tax level? That's just silly. Apple went years without paying a dividend and no one was discounting their cash by 15%.

        4) Even using your silly $33.54 cash level, you really think shorts would want a short a stock that has that much cash on the balance sheet?

        5) You seem to have the same stuborn position as management that the stock price is undervalued and EVERYONE else is wrong. Yet it just keeps going lower.

 
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