Two years and ten days after the AMR corporation — the parent company of American Airlines — filed for Chapter 11, the embattled corporate giant closed its banner merger with U.S. Airways and exited bankruptcy as the newly minted American Airlines Group, Inc.
With a market value of $18 billion, it laid claim to the title of the world’s largest airline. After years of weathering the notoriously tempestuous airline market, the blockbuster deal with U.S. Airways brought an end to one of the biggest bankruptcies of 2013.
And yet, fast-forward to today, and you will find that American Airlines holds a mere fraction of the cash assets it emerged from bankruptcy with, and the company’s stock is dramatically leveraged after nearly two years of aggressive stock buybacks. What happened, exactly? There’s no pretty way to say it: We feel executives went hog-wild over American Airlines stock — using shareholder cash.
Notwithstanding American Airline’s $19 billion in debt, executives at the Fort Worth, Texas-based corporation poured $9 billion in cash back into the marker last two years, according to the company’s financial disclosures.
This maneuver drastically reduced the airline’s cash assets, and — most importantly — it occurred without input from the rightful owners of that cash — American Airlines shareholders.
There’s no pretty way to say it: We believe executives went hog-wild over American Airlines stock — using shareholder cash.
That’s right. Under current law, it’s possible for management to empty corporate coffers of cash, ratcheting up risk for shareholders in the process, doing it all without first informing shareholders, or even asking their permission.
Before I explain how buybacks increase risk for shareholders, we need to broach what has to be an uncomfortable subject for corporate executives.
Executives get an “undisclosed commission” on buybacks
In corporate boardrooms and in the executive C-suites at most major corporations, we believe there is a colossal conflict of interest infecting the buyback process.
It’s illustrated for the world to see right here, in the case of American Airlines. Executives at AAL and most other corporations have the same conflict of interest relative to shareholders. Executives are incentivized to increase earnings per share. And it’s typically a doozy of a carrot: if they’re successful, executives can make 10x their annual salary, and sometimes much, much more. All they have to do is throw tons of buyback cash at the stock in an effort to drive down the share count, increasing earnings per share.
Executives are not incentivized to pay big, juicy cash dividends to shareholders. And so, in many instances, such as is the case here, executive self-interest does not mesh well with the shareholder’s best interest. And when there is a conflict, guess whose interest usually wins out?
For those intrepid souls brave enough to buy an airline stock (and I mean any airline stock), cash distributions and leverage considerations are a really big deal. Because of Corporate America’s screwy incentives — which essentially emphasize earnings per share to the exclusion of all else — and lack of shareholder involvement in the buyback process (with no vote, we don’t have a decent platform on which to stage a protest), important decisions affecting shareholder property are left to executives.
Buybacks increase risk for shareholders
Every $1 that is sent to the stock market for buybacks increases risk for shareholders. Since you’re taking cash out of a corporation, and not replacing it with another asset, buybacks increase leverage for shareholders in each and every case. That’s not to say buybacks are always bad for shareholders, just that they can be. For sure, buybacks are a more aggressive move for a board of directors to make than dividends or a do-nothing policy.
Today, if they had a do-nothing board, American Airlines would still be sitting on a boatload of cash. The cash would still technically belong to shareholders, even if they don’t have possession.
With a dividend, the corporation loses the cash (increasing risk for the corporation), but it ends up in the pocket of shareholders. And, naturally, that happy state (cash in pocket) reduces the overall portfolio risk for shareholders.
In the case of buybacks, the choice made by conflicted executives is the most aggressive path, from a shareholder’s point of view, relative to do-nothing and dividend-happy corporations. With buybacks, the corporation loses the cash and shareholders don’t get it either. Since they don’t get cash in a buyback, shareholders are put in a riskier investment position (more leverage) with buybacks than they would be otherwise.
For shareholders that invested in American Airline’s stock, did they really want executives to go crazy with leverage, emptying the savings account, with a business less than two years after bankruptcy? To go from over $5 billion in cash ($19 billion in long-term debt) to $550 million in cash with the same debt load?
This is not to say American Airlines was immediately put into a precarious or risky position by virtue of an excessive buyback. The company will likely be fine for the next few years, assuming business conditions are stable. But that doesn’t negate the cold, hard fact: The cash cushion has left the building. It was sent to the stock market, to fund buybacks, never to be seen again by shareholders, who instead received a higher ownership percentage in American Airlines stock.
What do you think? Do you think American Airlines shareholders are happy with an increased ownership percentage instead of a 25% cash dividend? Do you think shareholders got what they really wanted?
Of course we’ll never know what shareholders would’ve wanted because they did not get to participate in the buyback decision-making process. Shareholders were not asked if they’d prefer a cash dividend. American Airlines executives made the choice all by themselves: Shareholders didn’t want a big dividend. Shareholders wanted their cash sent to the stock market, to be swapped for 25% more ownership in a highly leveraged airline.
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