As a bull, the market’s lukewarm response to Micron Technology’s (MU) ambitious buyback program can seem a little mystifying. The buyback seems like a no-brainer. At current prices, Micron’s $10b budget is good for repurchasing around 20% of the firm and generating around 25% EPS accretion - both very large figures as far as buybacks usually go. Micron can afford it, though. The buyback will be funded with Micron’s massive free cash flows, even as the company keeps improving its already excellent balance sheet. What gives, then? Why has Micron’s buyback failed to bolster stock price, and even been accompanied by a deepening slump?
I argue that part of the reason is that Micron’s buyback presents an unusual investment scenario. Usually, firms engaged in massive buybacks tend to be financially strong. They tend not to be at the brink of making losses. However, according to some investors, Micron stands at precisely this brink. Since many investors are extremely fearful regarding Micron’s future profitability, we must remember that with a buyback, EPS accretion cuts both ways: buybacks compound both profits and losses. With most large buybacks, the bit about losses tends not to be very important because losses aren’t on the horizon. Not so with Micron - or at least investors’ perceptions of it. As such, it makes sense that the buyback has not generated much enthusiasm - and it could, in fact, even be a leading cause of the ongoing dip in market sentiment on Micron.
Here’s how the logic goes:
A. Without Profits, EPS Accretion Is Worthless
As we all know, the main rationale for any buyback program is EPS accretion - share count goes down, earnings per share go up. Or so goes the logic when a firm is actually profitable. However, for obvious reasons, this rationale doesn’t really amount to anything if the firm in question cannot maintain profitability. For a firm with zero EPS, all a buyback does is worsen the balance sheet and squander shareholder value. There’s no EPS accretion if EPS is zero, so the reduction in share count brings no benefit in return. The firm might as well set the money on fire.
Applied to the case at hand, if you think that Micron’s earnings will come crashing down to zero like a jenga tower, then the $10b buyback program is a waste of $10b. If Micron paid out a massive one-time dividend, then shareholders would get their slice of the $10b. If Micron just held on to the $10b, then it would show up on the balance sheet and get reflected in market capitalization that way. But if Micron repurchases stock, then investors basically lose the $10b in exchange for nothing if there are no future earnings to accrete.
Hence, if you think about the buyback from the perspective of a bear who expects - rightly or wrongly - that Micron’s EPS will crash down to nothing, then the buyback is a huge waste. This waste of $10b should then be reflected in a roughly equal decrease in market cap. Thus, from a bear’s perspective, the buyback is destroying Micron’s value and producing nothing in exchange.
B. With Losses, EPS Accretion Makes Things Worse
Moreover, should Micron start making losses, then the buyback would make things even worse. EPS accretion via buyback compounds both profits and losses. Should Micron start making losses, then these losses will be divided across a lower share count and the per-share hit for investors will become even larger. This is, as I have noted, not something we usually worry about with buybacks because firms engaged in buybacks tend to be financially stable and not in imminent danger of losing profitability. But at least according to some bears, Micron is in exactly this danger should memory industry cyclicality hit Micron hard. It’s happened before, so the idea is not entirely outlandish (at least in the short term).
Thus, if you are a bear who expects Micron to start making losses in a few quarters, then the buyback is more than just a waste of $10b. It also increases future losses. In this scenario, the buyback should not only lead to a reduction in market cap of $10b (due to waste), but also some further reduction in share price to reflect compounded expected losses. Even setting the $10b on fire would seem to be a better move if Micron makes losses in the long term.
Micron’s buyback therefore presents a unique investment scenario. Usually with buybacks, it is not important to remember that EPS accretion cuts both ways because the firm in question can reasonably be expected to remain profitable. Sure, there are debates about whether the buyback is good value for money, but usually not about whether the buyback expense will lead to an increase in EPS. The answer to this tends to be “yes” with most buybacks. Consequently, Micron’s case is rather unique because investors have doubts that the buyback will increase EPS - if Micron starts making losses, the buyback could even lead to a further decrease in EPS.
Given that Micron is currently in the grip of very bearish sentiment (as evidenced by being priced for disaster), and given that many investors are increasingly worried about its long-term profitability, it makes sense that the buyback has failed to bolster stock price. From a bearish perspective, the buyback looks like a waste - or worse.
But there are also some reasons for bulls to be happy. First, the above analysis suggests that if and when sentiment on Micron turns bullish again, then the buyback will likely compound this bullish sentiment. From a bullish perspective, the EPS accretion implied by the $10b buyback is massive, and if and when investors stop worrying about Micron’s basic financial health, they will likely start being happier with the buyback as well. Second, in the mean time, Micron is getting a great price on the buyback and is on track to reduce share count much more than investors would have expected when it was initially announced. If you have faith in Micron in the long term, and a long-term investment horizon, then the current slump in stock price is not a crisis but an opportunity - which Micron seems to be trying to capitalize on aggressively.
Disclosure: I am/we are long MU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.