Member Info for Nobull

"The bankruptcy risk/dilution risk changes when cash leaves the company"

“[The bankruptcy/dilution risk changes when cash leaves the company] if they dividend it out. But not necessarily, in either case, when they're distributing EXCESS capital. GKP has capital sitting in cash way in excess of its needs. That is THE very reason it is paying it out. They have the capacity to do about another $275-300m and then things normalise to paying out what they're actually earning in free cash flow.”

The book “Making the Right Investment Decisions: How to Analyse Companies and Value Shares” by ex Warburg analyst, Michael Cahill, explains what drives shareholder value in Chapter 1, the Valuation Villa, and he cites sophisticated concepts (at least from the point of view of reading company accounts designed to inform debt financiers of a prudent view of company’s financial standing) such as “value added growth” and “growth that doesn’t add shareholder value”.

He cites risk changes as being one of the many ‘returns’ shareholders get. Paying out ‘excess’ cash when you have debt finance increases the financial risk, and this is one of the ‘returns’ discerning, risk-averse shareholders don’t want. The cash return, whether as dividend or rise in the share price from a buyback is no good if the financial risk rise causes the share price to fall by a greater amount than the dividend or the share price rise from the concentration of earnings in a buyback. Financial accounts are at present far too primitive to convey this unless they are interpreted by someone like Cahill, Buffet, Terry Smith, Phil Oakley, etc who understand these concepts.

“A company doesn't trade in its own capital.”

It trades between those shareholders leaving and those remaining. Agreed these ‘trades’ don’t show up as profits or losses in the Income Statement or on the Balance Sheet. The success or otherwise of these ‘trades’ shows up in the share price to those with a sophisticated understanding of what drives shareholder value. Accountants and corporate finance geeks maybe are not sophisticated enough in their understanding of these matters.

“I'm done. You've shown an inordinate capacity not to listen and reflect. I would highly suggest, as I have done already, that you reflect some more. You will likely ignore it. That won't make me wrong. Good luck. Seriously, I wish you well Nobull.”
Yes, I am too. I haven’t changed my view one iota. I need to take a break and read more. I remain deeply suspicious our BoD (and its ghost writers, Celicourt) have the competence to understand buybacks properly. Agree to differ. ATB.

"It's interesting that someone who admits they have little experience in this arena chooses to argue so vigorously with someone who has been paid to advise on such issues for more than the last 35 years."

Pulling rank doesn’t make you right.

“The stake bought back - the company is buying its own shares. They are removed from circulation. The value of the company (ceteris paribus) goes down by the value of the cash leaving the company - number of shares bought x price they were bought at.”

No. The bankruptcy risk/dilution risk changes when cash leaves the company, perhaps imperceptibly to you, but not to me.

Risk increasing requires the company valuation to fall, at least in an efficient market. So if a large amount of cash e.g. $100m leaves the company to do a buyback, when the company has $100m of debt, the dilution/bankruptcy risk rises quite a bit, especially with our equity base, and for me that requires a fall in the share price beyond the amount per share that is being distributed; that’s value destructive to my way of thinking. Think of a company overdoing the dividends – after a while it might get de-rated to reflect the risk of having to do a dilutive placing at a share price not of its choosing.

I get that accountants aren’t interested in such things, and this is probably why Terry Smith is calling for the way buybacks are treated in the accounts to be changed, something which is necessary to clamp down on buyback abuses, but to your way of thinking such abuses don’t and can't happen.

“ There is no investment. The company isn't trading against its own shareholders in its shares. The only people investing are those individuals who forego the cash distribution, ie don't sell into the buyback, and as a result increase their ownership in the company at the buyback price.”

When a company does a buyback it is trading between those selling up and those remaining. Those selling up can be paid too much, in which case those remaining are being fleeced by those leaving, the DCF value associated with the shares involved, and whether the shares were purchased above or below the DCF value, determining whether the deal was value-accretive for the remainers. Same problem with transfers from one pension fund to another.

I hope you understand my point of view better.

"Company buys back shares and parts with cash. Company cancels shares bought back. Company has parted with cash for nothing in return. Where's the investment?"
The investment is the DCF value added, as represented by the stake bought back. This DCF value is then distributed among the remaining shareholders when the shares are cancelled. Don't you get it? The distributed DCF value needs to be greater than the price paid otherwise it isn't value-accretive.

"Dividends and buybacks distribute value; they don't create it."

No. If you buy shares below intrinsic value thousands and thousands of times, you will, like Buffet, on average be making excess returns for the risk taken. You seem to be ****ging off DCF valuations because they can be done both by CFA qualified professionals and by nincompoops - the maths isn't difficult, but making reasonable assumptions is. The uncertainty over the quality of an income stream can be handled by using a higher discount rate.

A dividend is just cash, but a buyback is an investment, which like all investments, needs to produce an excess return to be value-accretive. The probability of it being value-accretive is much higher if the buyback is done below intrinsic value (as calculated by professionals, that is professionals with the expertise to make reasonable assumptions).

Dividends and buybacks are not merely distributions: buybacks need to be done below intrinsic value or not at all. Our Chairman needs to be cross-examined in detail about the last buyback, given he called it value-accretive when it plainly wasn't. It is always prudent to have the general authority to do buybacks, but that authority should not be abused.

"something wrong somewhere, I can’t quite put my finger on it ,??? Any suggestions???"

Huge uncertainty here about the earnings stream quality. Are we one of the 20%? You can buy exactly the same FY2022 eps forecast as we have for 4 times the price by buying MP Evans (both companies have the same year end and both companies are producers of a primary commodity priced in US$). The uncertainty is compounded by our Chairman's refusal ever to take a stake in the company himself while claiming the BoD is aligned with us; they are on the upside, and not at all on the downside, except in the cases of PLG, JH, IW and GS.

"There is no perfect model for calculating the actual intrinsic value, so whatever is calculated has to be a opinion. "
TM, hi. Agreed.

"For some reason, probably somewhere between £2 and £4 guv’ is not the answer people want to read :) "

When the range is as wide as that, then the uncertainty is huge, and that should be a good reason NOT to do a buyback as one can't be certain of it being value-accretive. Another reason not to do a buyback might be if the price to book is > 1, for by not doing a buyback, the cash is part of the capital employed earning x%, whereas after the buyback, the cash is deployed having an ROCE of x% divided by the price to book, the price to book, which if over 1, reduces the ROCE, and of course the share price at which you do the buyback affects the price to book ratio, something which Putup is in complete denial about for according to him, buybacks are just distributions and the price doesn't matter.

"How many different professionals, using different methods would a company have to use to get a “reasonable” spread of guesses and would it necessarily lead to a useable value to justify a buyback taking place or not?"

I think it would be great if our CFO was forced to disclose his assumptions as to why a buyback was likely to be value-accretive before he does one. This would stop our BoD abusing buybacks to deliver themselves shed loads of free shares if that was the reason they did the last buyback (I don't know that that is the reason as I haven't read the performance criteria that need to be met). I suspect buybacks are only a good thing when a business has a stable business model with stable growth rates and the shares are cheap perhaps because they've been dragged down in a general market flash crash. Yes, I get that buybacks avoid the inefficiency of dividend taxes, but those efficiency gains can maybe be thrown away by buying on a price to book greater than one, I wonder?

"And what is the magical "intrinsic price" of GKP right now?"

No idea. I am not experienced enough at doing DCF calculations to have a good enough feel for them, but I'd probably start with a 14% discount rate and a long term oil price of about $50 a barrel. I'd probably ignore the return of the cost recovery pool (or model that part separately). For future production, I'd probably model 50k bopd for about 10 years. I'd probably ignore the FDP/future capex for expansion. I don't have figures for long term running costs and maintenance capex. And that's about the nearest I've got to even thinking about an intrinsic value per share. The actual calculation is quite simple from a maths point of view; it's the inputs to the calculation that are difficult to get right. I'd need to check any valuation thus produced against other valuation methods to make sure it sounded reasonable. SimplyWallSt has a DCF value £2.98p, but I don't trust it - they use a very low discount rate, and I haven't worked through their method yet.

"But the way that whole buyback was engineered is troublesome to me."

It troubles me too. It troubles Investors Chronicle too, I wonder, for they referred to "corporate governance issues" in one write-up. I don't like the way a lot of people do not understand buybacks (including our Board) and how they think it doesn't matter what share price they do a buyback at. Putup still doesn't get it. Happy Easter Putup; carry on. Even Warren Buffet thinks buybacks need to be done below intrinsic price, but there's no convincing Putup. I am p*ssed off about giving up some of my risk-taking reward to the HR director.

"A better looking set of nos reported by REA"
Yes, JL, but the tax charge is over 60%! Another negative eps figure again. A lot of it is fluffy stuff - intentions to do extension planting, expectation to sell a million tonnes of stone over 2 years, etc. All a bit disappointing. The high CPO prices will drop off next year when Ukraine plants a sunflower crop next April, I wonder? Coal prices can't possibly stay above $300 a tonne for long, surely? We need $24.3m to deal with the pref arrears and pref divs due this year, and that's to just stand still. JMV.

"The excess cash needs to be earning at least the cost of capital to generate value."

Agreed on that and agreed that the present value of a stream of instant access cash account bank interest, discounted by the company’s cost of capital is going to be close to zero, and therefore any buyback, on that basis, even one above intrinsic value, might be value-accretive in that case.

But the cash has an opportunity cost: it can be invested in buying another development project, in expanding or maintaining our production, in paying down our debt as well as of course in buying back our own shares or indeed the shares of another company.

The notional return to our cash is the value of the best opportunity foregone (due to spending it on the buyback). The incremental DCF value added by the buyback needed to at least exceed the lost value from not paying down our debt. A shortage of net cash later (and delays by the KRG paying us), as the pandemic got underway, meant we had to waste money buying an oil put option to limit our bankruptcy risk (with more cash we wouldn’t have needed to bother). No, I don’t expect our Board to predict oil price crashes and future KRG payment defaults, but when deciding whether to do a buyback, you do not use the HSBC US$ instant access cash account interest rate to determine the value of the cash being lost to the company to execute a buyback. A prudent CFO, looking to do the best for all shareholders (as opposed to for individual directors with LTIPs and VCPs with performance criteria that may or may not be helped to be met with the aid of a buyback) sets a higher hurdle rate to make the right decision.

And you think GKP had excess cash at the time of the buyback? You’ve maybe forgotten about the $100m of debt we also had. If they did have excess net cash, the size of the buyback was far too large in relation to the actual amount of net cash, I wonder (regardless of the eventual outcome).

The opportunity cost of cash can be very high, because if you ever run out of it, the price of raising it (perhaps when the oil price is low) can be exorbitantly expensive (ask anyone who was diluted out by the last debt for equity swap here how value destructive that was).

To help me decide whether a buyback was value-accretive, I wonder if using the average return on equity through out the oil price cycle as the interest rate earned by the cash would be the right way to go about it, and then see if the incremental DCF value added by the number of shares I could buy to be cancelled added more value than the DCF value of the cash lost.

Obviously the lower the share price you buy the shares for, the more DCF value is added, so it is utter twaddle to say that the price paid for the shares cancelled doesn’t matter. IT PLAINLY DOES MATTER. I don’t know how to put Terry Smith’s, Warren Buffet’s and Phil Oakley’s views on this into an algebraic equation. I give up trying to convince you.

"There are many PIs, including bb contributors here, who did not invest in GKP based on detailed/or even any DCF analysis."
Neither did I. I bought because I naively thought the shares would outperform the oil price. I maybe boobed: the oil price has outperformed GKP in terms of CAGR. I have't taken into account TSR because I don't know how I'll be taxed on the dividends. I get that many 'shareholders' are just interested in passing their shares on for more than they paid regardless of share price sensitive events, and that they haven't the slightest interest in understanding their investment or holding the BoD to account.

Putup, you spend a considerable amount of your posts ****ging off DCFs (you can’t admit that the value of the cash lost to the company doing a buyback is greater than the face value of the cash actually spent on the buyback), asserting moral superiority because the accounting treatment of buybacks agrees with your twaddle that buybacks are just an alternative way of distributing retained earnings: they are in the accounting sense, yet you must like DCFs because you say you’ve done loads in your life, yet you won’t allow the cash leaving the company to include the discounted value of its associated future profit stream. Hmm.

I repeat my own understanding of Terry Smith’s views: the incremental DCF value added by the purchase of each share for cancellation must be not be less than the DCF value per share of the cash being lost. Otherwise, value is being destroyed.

I also repeat Terry Smith’s view “One of the most important facts that is continually overlooked is share buybacks only create value if the shares repurchased are trading below intrinsic value and there is no better use for the cash which would generate a higher return.”

Intrinsic value, as you know, is fair value or DCF value.

Finally, GKP trades on a price to book of 1.3x and has an ROCE of 26.24%. So if you bought shares back for cancellation at today’s price, 1.3 x book price, you would, at the margin, be redeploying capital to earn only 20.2.%. In that case, why not redeploy the cash to earn 26.24% at 1 x book value (not do a buyback)?

There are some extremely self-serving reasons why companies do buybacks (often to trigger shed loads of free shares being issued to directors, and buy-backs, if I’ve understood them right, can be value-destructive for us, even if eps rise as a result, which is a strange paradox, if true), and our Chairman (or his ghost writer, Celicourt) has already told us a load of *******s about the last buyback being value-accretive – I don’t know if this is because he doesn’t understand them fully himself or if he was flat-out lying. Sh*t, if the Lex column writer gets it wrong, why should our Chairman understand them – he’s an oil man.

P.S. I wasn’t inviting you to participate on ADVFN, just to look at an image I posted of an equation that would need to hold true if your twaddle about buybacks just being another means of returning capital were true: as I’ve said, it’s slightly more complicated than that, and Warren Buffet, Phil Oakley and Terry Smith also seem to think so.

Putup, post 651975 on ADVFN shows a bit of algebra to show what your argument implies if buybacks never create or destroy value and are just a return of excess cash.

Correction
because the incremental DCF value added by the purchase of each share for cancellation is less than the DCF value of the cash PER SHARE being lost .

“Nobull. I've done literally thousands of DCFs over the last 35 years. Smart cookies those fellows at Lex.”

So you will know the amount expended on the buyback is less than the DCF value of the cash that is lost to the company.

While the cash leaving the balance sheet (the accounting treatment) is the same as the amount spent on the buyback, the true loss of the value of the cash to the company is more than the cash expended on the buyback.

The cash on the balance sheet has an associated profit stream of its own, albeit one that is subjective and that is yet to materialise, but in DCF terms, that associated profit stream attached to that cash, whether it’s ascribed a DCF value on the assumption it will compound at the available ‘instant access cash deposit’ interest rate or compound at the IRR on funds used to expand the business is neither here nor there.

Accountants are there to please bond investors, not equity investors, so they follow the prudence concept of not assuming a profit stream will arise from that cash in the future, so they don’t, and indeed aren’t allowed to, put the DCF value of the profit stream associated with the cash on the balance sheet, but it has a value, and it has been lost to the company, even if the accounts don’t show it.

That lost value therefore has to be replaced with an as good or better investment, the purchase of the company’s own shares. If those shares are purchased at the wrong price (above the DCF value per share, a.k.a .fair or intrinsic value, before the buyback was done) value will be destroyed, because the incremental DCF value added by the purchase of each share for cancellation is less than the DCF value of the cash being lost . That’s my understanding of what Buffet, Terry Smith and Phil Oakley are all saying. I agree that the Lex column writers are smart people but like you, they, can, on very rare occasions, get things wrong.

My understanding of your argument is that the DCF value per share before the buyback must be the same as the DCF value per share after the buyback, all other things such as the discount rate used remaining the same. If this doesn’t make sense, then I would have to prove your argument is false by algebra. I prefer to remain in agreement with Buffet, Terry Smith and Phil Oakley on this one.

Terry Smith widsom on buybacks:
3. Investors and commentators should use return on equity to
analyse the effect of share buybacks rather than movements
in earnings per share
4. Share buybacks need to be viewed with more than average
skepticism when done by companies whose management
are incentivised by growth in Earnings Per Share

(Do our LTIPs and VCPs make eps growth one of the performance criteria for our BoD to pick up a shed load of free shares?). This might be the true reason for the buybacks.

Correction:
"There is no reason why the numerator and denominator have to remain in lockstep PROPORTION after the buy back compared to the situation before."

What to do?
We [FundSmith] would suggest the following conclusions from all this:
• Share buybacks are not sufficiently understood by company
investors and commentators, and maybe by company
managements (although some of them may understand
them perfectly well but not be using them to create value
or anyone other than themselves)
• Share buybacks only create value if the shares repurchased
are trading below intrinsic value and there is no better use for
the cash which would generate a higher return
• Current accounting for share buybacks conceals their
true effect
• Most share buybacks now destroy value for remaining
shareholders

"They neither create nor destroy value. The simply distribute cash. (Do the DCF exercise.)"

Agree to differ then. I am never going to agree with you on this. That said even the FT Lex column has made the same mistake as you have. The FT Lex column said on 8th January 2010 "The way in which cash is returned to shareholders is irrelevant", the same crap you are spouting, and the FT ought to know better.

It is highly relevant how cash is returned. There are various articles in Investors Chronicle on the buybacks done by Rightmove plc and by Next Group, all analysed by Phil Oakley. I have posted an image for you to look at on ADVFN from Terry Smith's publication "Share buy backs - friend or foe", Post No. 651956 . You are the one who needs to read it, not me have to prove that numerator (DCF value of a company after the cash has left) and denominator (no. of shares in issue after a buyback) has to be equal to the same equivalent fraction using the numbers for the numerator and denominator that represented the situation prior to the buyback. How hard is it for you to grasp that? Don't be a plank - we are not calculating Planck's constant here! There is no reason why the numerator and denominator have to remain in lockstep after the buy back compared to the situation before.

"What you don't get to do is to come back 3 years later and blame management "

Agreed. I haven't. I have stated in other posts that the BoD could not have foreseen the oil price crash and the pandemic (I do not blame them for buying at the wrong price). Also the person I advised to buy in April 2020 benefited, and now me, as I inherit the shares, from getting in at a lower share price than they otherwise would have. It took me a while to realise that, but my big bug bear is our chairman calling the buyback value-accretive at the time he did when it plainly wasn't: it wasn't for the existing shareholders at the time, but it was for new investors like my relative. I am glad you now agree that buybacks destroy value when executed above fair value and that there is more to buybacks than just seeing them as returns of excess capital.