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Europe firms may draw fire by joining buyback boom

The logo of Carrefour is pictured during the company's 2013 annual results presentation in Paris March 5, 2014. REUTERS/Benoit Tessier

By Lionel Laurent

LONDON (Reuters) - European companies are likely to join a boom in share buybacks as central bank cash floods the economy, risking criticism that they are recycling capital rather than investing to promote growth.

European firms are already cheering financial markets by increasingly following their U.S. counterparts in returning cash to investors, propping up their share prices while the euro zone economy remains sluggish.

But with the European Central Bank starting a 1 trillion euro stimulus program on Monday, political pressure will probably grow on companies to use ultra-cheap funding for creating jobs rather than simply buying back their own shares.

In the United States, years of Federal Reserve stimulus aimed at reviving the real economy led to the wave of share buybacks while firms neglected capital expenditure (capex).

Few people expect European firms to match the staggering sums in the United States, where over $2 trillion of stock was bought back between 2009 and 2014, according to Reuters data. Nevertheless, about $8 billion worth of buybacks have already been announced by a dozen European companies this year, including ABInbev (ABI.BR) and ASML (ASML.AS).

That appetite is likely to keep growing: European firms have over $1.5 trillion in cash on their balance sheets and few obvious places to reinvest it to earn a return. Borrowing costs are already at record lows relative to their earnings power, and with the ECB set to depress rates further with its quantitative easing (QE) program, buybacks are an easy answer.

If the United States is any guide, big buybacks will attract criticism. A report by Barclays from September found that, even though capex remained the top form of U.S. cash-flow spending, the rate of growth of buybacks had far outstripped capex and this meant less cash was being reinvested for growth.

"The debate over corporate spending will increase, especially in Europe, where there is more of an attempt to balance both government and the private sector," said Martin Schulz, portfolio manager at Cleveland, Ohio-based PVC Capital Advisors.

"With QE, the average voter thinks they are going to get all this free money ... There's the expectation that corporations are going to reinvest cash. The political pressure will grow."

French companies got a taste of this last year, when President Francois Hollande told Le Monde newspaper that bosses should use tax credits to reinvest and hire instead of paying out dividends to shareholders.


Capex has by no means evaporated; for example French retailer Carrefour (CARR.PA) said on Thursday it would lift capital spending in 2015 to cement a revival in its European hypermarkets. But as a proportion of net sales, capex has declined globally since the 1990s, according to a 2013 OECD paper.

In the United States, dividend payouts and share buybacks rose more than 40 percent between 2010 and 2013, eclipsing capex and effectively turning firms into "giant capital recyclers", according to a Citi research paper in 2014.

By contrast, a survey by the U.S. Industrial Research Institute found that more than two thirds of laboratory and R&D leaders expected little to no change in their budgets in 2015.

While one might have expected more spending on mergers and takeovers, Barclays' figures suggest most of the rebound in U.S. deal-making after the financial crisis was paid for in stock, with the cash component declining.

But European firms won't necessarily become giant capital recyclers, borrowing funds just to buy back shares, in large numbers.

Apart from the biggest corporations, most rely on bank borrowing to raise debt and European lenders are less likely to have the capacity to fund buybacks that do nothing to boost future profits than the bond market, where many U.S. firms get cash.

"The way QE is going to be transmitted over here is very different ... The corporate debt market is significantly smaller," said Tim Crockford, portfolio manager at Hermes Investment Management.

Executives' pay is also less tied up in stock options than in the United States, investors say, making another factor that might discourage a buyback frenzy in Europe.

However, European buyback volumes remain well below their pre-crisis peak - totaling $38.3 billion in 2014 versus $157.8 billion in 2007 - giving scope for growth. Lucrative reinvestment opportunities are also likely to take more time to find and win board approval while the economy remains weak.

"In Europe, we are not yet in a phase where we will see the use of balance-sheet (spending) on capex," said Valentijn van Nieuwenhuijzen, head of multi-asset investing at ING Investment Management. "The exception may be Germany, which is in a different phase of recovery. In the rest of Europe, a move into capex will be at least a couple of years away."

(Additional reporting by Sujata Rao-Coverley and Blaise Robinson in Paris; editing by David Stamp)