Public Companies Borrow Money to Give to Shareholders

The Wall Street Journal reported on 3/27/07 that some public companies - such as Scotts Miracle-Gro, Domino's Pizza, Health Management Associates, and Deans Foods - are borrowing money to repurchase shares and offer dividends. In other words, they're going into debt and taking on risk to distribute cash to the people and institutions that own them. Some number of people in the investment community seem to think that this is a good idea:

"This is long overdue," says Robert Sellar, head of North American equities at Aberdeen Asset Management, which has $148 billion in assets, adding that "companies in the U.S. are underleveraged."

Maybe I've just become a fuddy duddy, but to go into debt to pass around the cash seems the equivalent of taking a home mortgage to go on vacation. It's fun, but eventually someone has to pay. The underlying assumption behind these transactions is that companies will remain profitable and that economic conditions will stay positive. Given what is happening in the housing market - subprime mortgates in trouble, meaning more houses on the market, lower prices, more people trapped by highly leveraged higher prices from the past - and that some like Greenspan see the potential for recession on the horizon, this seems like foolhardiness.

As the article further notes:

The best candidates are typically firms in maturing industries with slower expansion profiles, and whose shares are trading at low earnings multiples, notes Stefan Selig, vice chairman of global investment banking at Bank of America Corp., which also advises companies on such transactions.

If the industries is mature and management teams feel that there is too much capital tied up in low return uses, then maybe they should consider potential new brands/ventures and a reexamination of their current strategies.

I think the degree of underlying lunacy of this approach is apparent at the end of the article, where the CFO of Scotts Miracle-Gro is quoted as saying that "operating with more debt 'encourages more discipline' among management." And mortgaging your house up to your eyeballs encourages future budget discipline in a household. Oh, please, spare me.