💎Bringing Back: Buybacks, Valuations & Supply Chain (03 April 2022)

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At times, it's not about constantly moving forward and doing the next thing. Rather, it could be about taking a step back, if that best suits the situation. This week, we look at such pivoting business moves.

BUY BACK SPREE

As per Goldman Sachs, S&P 500 firms bought back USD 238 billion worth of shares in the first two months of 2022. The bank has forecasted that the full-year total could rise by 12% to USD 1 trillion.

Generally, the company’s management portrays buybacks as their confidence in the company's growth and execution abilities, but there is more to it!

How does it work?

When the pandemic hit in 2020, many companies piled up cash to deal with the uncertain circumstances. There are two ways the cash can be usedinvest it back into the business or return it to the shareholders.

Share buybacks generally lead to a boost in the demand for the company’s stocks and increase the earnings per share basis by reducing the number of shares in circulation.

The two sides:

- Supporters say buybacks can be a prudent use of cash when there are no better alternatives, so better to give money back to shareholders to reinvest where they see fit

- Critics say that buybacks puff up executives’ stock-based compensation by raising stock prices. Also,at the same time, it diverts the funds away from research, capital expenditure, or salaries, which are beneficial for the company's growth in the long term

Our take

US regulator, the SEC, recently proposed for the companies to abide by certain clauses while declaring buybacks and at the same time be transparent about the reasons. Even if that means stating that you couldn't figure out a more constructive use of idle cash!

Time for Indian regulators to take some lessons. Management might have tough times ahead to deliver earnings during inflation and supply bottlenecks. Buyback then should not become a tool to spike earnings in the short term and please shareholders

TRIMMING DOWN THE VALULATIONS

The US-based grocery delivery startup, Instacart, has slashed its valuation to USD 24 billion from USD 40 billion a year ago. This is a huge 40% blow and a rare instance of the startup itself taking the valuation cut.

Instacart said market conditions, that are out of their control, have pushed down the valuations of its peers. Similar startups in the listed domain such asDoorDash is down about 22% and Shopify is down about 35% from a year ago.

The bright side...

Commonly, valuations are marked down during a funding round. This case is different as Instacart decreased the valuation under 409A, which is used to price stocks reserved for employees.

Instacart is granting company stock using the new valuation, rather than the previous price, and this will give employees more share units. Might help the company to retain and hire the right talent.

Other reasons for the trim

- The narrative that covid changed consumer behavior drastically did not prove right and business models built on the same thesis are not able to deliver as per the expectations

- Increase in inflation and fierce competition in the online delivery space might impact user retention and revenues

- The existing war plus pandemic situation does not seem so promising for the business growth

Our take

Post pandemic times certainly have valuable lessons for investors. Any business should be analyzed from a long-term perspective and with multiple scenarios simulations, definitely including the worst case.

It's good to own a company with diversified offerings that can bear different market cycles. Eventually, employees owning stocks might also want to invest their careers with firms that are backed by a strong business model.

HOME COMING

Since globalisation kicked in, many firms moved a significant portion of their production offshore to bring down costs, especially through inexpensive labor. This led to higher income levels and increased savings in the emerging countries.

But lately, the pandemic, strained relations between countries, and war have led to supply chain disruptions and many companies are bringing production back to their home countries.

What has changed?

The rise in wages in developing nations and increasing crude prices have led to higher costs. Further, with ample options available, customers have become time-sensitive and any delays in deliveries make them opt for alternatives.  Also lately, there has been a drive to use indigenous and sustainable goods—we too have our make in India campaign.

Some recent turbulences

- For semiconductors, the world is dependent on Taiwan and South Korea. The ongoing shortage of such chips has highlighted the flip side of it

- Europe’s reliance on Russian oil and gas has made its way into the consciousness of many people due to the recent war

- China’s decision to no longer import world’s recycled waste left municipalities and waste companies from Australia to the U.S. looking for alternatives

Our take

Dismantling production is not an easy task. Companies need to deal with long-term contracts for leasing assets, supply of materials, and human resources among others. In addition, they have to figure out the re-integration into the business ecosystem of their home country. All of it makes a swift exit impossible.

A decision around which all parts of the supply chain are to be restored is critical and requires careful consideration from economic, business, and regulatory perspectives.

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