To call SocGen’s Andrew Lapthorne an ardent critic of financial engineering would be to grossly understate the case.
For years, Lapthorne has criticized the leveraging of corporate balance sheets to repurchase inflated shares. If there is one theme that pervades Andrew’s research, it’s that rising corporate debt is clearly linked to buybacks, and to the extent excessive leverage is inherently a bad thing, it’s even worse when employed in the service of “artificially” boosting share prices and EPS.
“Borrowing money to buy back your elevated shares is clearly nonsense”, he famously wrote, some years back.
In March, Lapthorne scrutinized what he suggested is a misguided approach to conceptualizing corporate leverage. That was but the latest example of his efforts to dispense with the idea that financial engineering isn’t as big of an issue as critics suggest.
Well, in a note dated Monday, Lapthorne warns that “US net debt is once again rising at a near record pace [with] 80% courtesy of new debt.”
Back in January, JPMorgan’s Dubravko Lakos-Bujas remarked on the rising “quality” of buybacks, where that means share repurchases are increasingly funded with cash, as opposed to debt. “Buyback executions in 2018 have been some of the highest quality of this cycle as they have been predominantly funded by cash rather than debt, a trend we expect to persist into 2019”, he wrote, referencing the following visual.
Obviously, some of that was down to the tax cuts, repatriation and surging corporate profit growth. On Monday, SocGen’s Lapthorne cautioned that “cash on US balance sheets is now falling rapidly”.
That raises questions about how corporate management teams will fund buybacks, especially in the event debt markets become less forgiving later this year. “US companies will likely increasingly struggle to afford the announced $800bn in buybacks”, Lapthorne contends.
During the Q1 rally, buybacks played a pivotal role, as key investor cohorts remained sidelined thanks to some lingering PTSD from the Q4 rout.
Remember, when it comes to sources of equity demand, it’s not even close…
Read more: It’s (Still) About The Buybacks