Question: Why don’t companes take a loan at current interest rates, and use it to buy back their shares?

I have a simple discussion question for listed firms in USA. Why don’t you take a loan at current interest rates, and use it to buy back your shares? Taking into account factors like your current and future dividend rates, interest rates, one time costs, etc. then this move may be shareholder friendly. Thoughts? Issues?

Tharendra Lunia: It happens but increasing leverage increases risk and increased risk means increased return expectations. Value = Performance/Expectation

Prashant Rishi: That’s called Leveraged Recapitalization. You can see how Sealed Air increased shareholder value by doing this.

Prashant Rishi: LBOs work on the same principles.

Prashant Rishi: But this works only in special cases like very stable operating cash flows, high business assets that can serve as collateral

Punit Jain: Sure Prashant. I feel if interest rates fall enough, this move becomes profitable for more firms …

Prashant Rishi: Yes, plus it’s important to structure this transaction as a long-term, fixed-rate loan from bank; to eliminate interest rate risk

Prashant Rishi:…/dp/0521642604 . It’s an amazing book that not only shows dynamics of LBOs and how KKR successfully executed them, but also the effect of debt on managerial incentives & organization culture. Also, depicts examples of how KKR burnt their fingers in LBOs like RJR Nabisco.

The New Financial Capitalists: Kohlberg Kravis Roberts and the Creation of…

Tharendra Lunia: Looking Amazon. Amazes me…

Shon Zhankin: I assume that if you take more loan your valuation go down and the overall effect from buyback will be zero or even negative.

Brett Fox: Like some of the others have said, I wouldn’t recommend doing this unless you are growth in free cash can fund the loan. A better way to fund a buyback is directly through the growth in free cash flow. This is a much cleaner way to go.

Frank Wen: Think apple did this?

Deepak Jindal: not a good idea.

Shon Zhankin: In 70’s investment banker Michael Milken from Drexel made almost the same. There is a book about him called Vanity Fair. He issued bonds to finance acquisition and privatization of the large public corporations by small companies. Then they put the debt on the balance of acquired corporation and sell assets of the corporation by parts some times. They did it with famous Revlon cosmetics manufacturer for example. After such an operation company become so indebted that it can’t finance its further development anymore. He became a billionaire at that time and received 20 years in jail for his transactions as he was a real threat to corporate America and the people who own corporations.

Punit Jain: Brett Fox I agree with you on your point. Of course one assumes the free cash flow is growing. However my thinking is that USA is a low interest economy today, and that can change in 1-2 years. So there may be a window of opportunity open now.

Punit Jain: @ Frank Wen I think Apple has cash in other geographies, but is listed only in USA. So to reward shareholders it took loans here and did a buyback. It remains net cash positive. This was smart from a cost, tax and shareholder perspective.

Punit Jain: @ Shon Zhankin of course if a company’s debt increases beyond a comfort band, its assessed negatively by analysts. So this move is not advised if there is high debt on the books already.

Punit Jain: Thank you dear responders for your wonderful perspectives and contributions !!

Punit Jain: Let me try to give you the India perspective. Here the corporate loans are available at 10 to 12% interest per annum. It appears to be 3.25% in USA. Surely companies will behave differently in their attitude toward debt if interest rates are different.