British defence and aerospace firm BAE Systems has announced that it is to embark on a share buyback programme. The company plans to repurchase over £1 billion worth of its stock over the next three years.
The company is in the fortunate position of holding significant cash reserves. These mainly come from its market leading defence business, a major supplier to the US and UK governments and also an increasing number of emerging powers such as India and Saudi Arabia; its cash reserves are not being significantly depleted by servicing debts or pension deficit payments, which both often place significant demands on a large corporate's balance sheet. But BAE's debts are low and its pension deficit, although large, is being effectively managed.
Another reason for BAE finding itself with spare cash on its hands is its ongoing failure to locate appropriate acquisition targets or merger partners. There have been rumours in the past of an alliance with fellow engineering company Rolls-Royce, but a deal has never come close to fruition. In 2012, a tie-up with European aerospace conglomerate EADS was on the cards, which would have given BAE significant opportunities to grow its non-military operations and its presence in geographical markets in which it's less strong, particularly Europe and Asia-Pacific. However, the EADS deal fell through because of opposition from the German government, a significant EADS shareholder, which left BAE stranded without an obvious growth opportunity to invest in.
BAE might have a considerable cash cushion, but these are undoubtedly difficult times for the defence industry. US sequestration, cost-cutting measures across all areas of government spending to reduce the US budget deficit, will undoubtedly affect BAE's revenues, as will reductions to UK defence spending by the coalition government and continued low growth in general across Europe.
Lessening military spending in the US and Britain is already having a direct impact on BAE's operations. BAE has recently announced that it might have to cut 3,500 jobs in its US ship repair business after the US Navy indicated that it may be forced to cancel some of its currently scheduled ship maintenance requirements.
In the UK meanwhile, it looks likely that BAE will close one of its UK shipyards due to a lack of upcoming work. This will probably be its base in Portsmouth, the home of the Royal Navy, potentially leading to the loss of around 1,500 jobs.
Thinking like a banker
Back and forward
Corporates often use share buybacks as a way to boost the value of their shares and hence the overall market value of the business - reducing the supply of available shares increases demand for them. BAE's shares are currently arguably undervalued, with their forward earnings multiple considerably below the defence industry average. And even the announcement of the buyback programme has had an effect on trading in BAE - its share price quickly rocketed by 6 per cent and has stayed at this higher level ever since.
Thinking like a lawyer
Stuck in the Middle East
Final go-ahead for BAE's share buyback programme is subject to the successful resolution of discussions with the Saudi government over the price at which BAE will supply the Gulf state with 72 Typhoon fighter jets. The contractual negotiations, likely to have involved corporate lawyers, have been so prolonged that BAE was forced to warn in December that the holdup would cut its earnings per share figure by around 3p. The dispute is thought to hinge around the issue of whether the current £4.5 billion price tag for the fleet should be reduced to reflect the downturn in the global economy.
Thinking like an accountant
BAE's accounts for the year ending 31 December 2012 showed it was holding net cash of around £400 million. And when a company has some money to spare, accountants tend to see buying back shares as a sensible way to spend it, especially if its shares are undervalued in the market and so a good deal, as BAE's arguably are. First, there are tax advantages for the shareholders being bought out, as capital gains are generally taxed less heavily than dividend income. And what safer investment could a company make than itself?
Thinking like a consultant
Don't just sit there
I see this deal as a strategic move as much as a financial one. BAE looks like a business without a plan after the collapse of its exciting potential merger deal with EADS. In addition the fall in military spending in the UK and US, BAE's two most important markets, is making the whole defence industry look sluggish. This buyback should not only increase the financial value of BAE shares but should also boost investor confidence in BAE, if only by making it look like it's doing something. But I'd suggest that investors should be worried about BAE's current lack of purpose.