Buybacks & Bailouts: Wall Street Thinks the Profits Are Theirs

In January – and yes, it seems like an age ago – I was on a Delta Airlines flight out of Vancouver. As I boarded the aircraft, the cabin crew were in high spirits. Smiling, joking, shaking hands with passengers, thanking people for flying Delta.

I said to a flight attendanspacet, “You all seem pretty happy. Is there something special?”

“Oh,” she replied. “We’re getting an extra two months of pay as a bonus.”

I congratulated her. It’s always nice to get a bonus!

As it turns out, Delta made a respectable profit in 2019. And management announced a payout of $1.6 billion to all of its 90,000 employees. This was in addition to the company’s 401(k) matching plan and other benefits.

I’ve been thinking about these happy Delta employees and their bonus in light of the utter disaster that has befallen airlines in just the past couple of weeks. Passenger volume has tumbled, thousands of flights are cancelled, airplanes are being parked in the desert. Plus, we have massive layoffs, with forecasts of bankruptcy.

Delta’s decision to pay the bonus was made before the current calamity. And fate was being kind! In retrospect, that extra two months’ pay will come in handy to anyone who banked it.

Of course, if the high-level “investor”-class had gotten their way, those bonuses might not have existed at all.

As Delta CEO Ed Bastian tells Forbes, he always gets flak for being so generous with his company’s gains.

“For years, I would get beaten up by Wall Street,” he said. “They thought the profits were theirs, and ‘Why are you giving the profits away to the employees?’”

In other words, by approving the bonus, Bastian bucked Wall Street. Good for him!

Still, Bastian identifies a major problem. Wall Street has long thought that “the profits were theirs.”

And too many corporate management teams seem to agree, simply running their companies to please the Wall Street handlers.

Now that the economy has blown up due to coronavirus, however, the same companies that paid out big cash to Wall Street want government bailouts.

Let’s drill down on this…

There’s no shortage of struggling industries these days.

Airlines, cruise ship operators, hotels, casinos and many more. They want a bailout. Tens of billions of dollars, to begin the ante.

Perhaps none of these requests, however, is more egregious than the ones coming from lobbyists for airplane-builder Boeing.

The company was already struggling thanks to mishandling of the B-737 MAX, which led to a pair of deadly accidents. (I discussed this on Dec. 18.) Now with the coronavirus raging, Boeing has exhausted its multi-billion-dollar credit line. The money-well is dry.

So it’s asking Washington to throw $60 billion its way.

On the surface, it has a more compelling case than other companies that are looking for bailouts.

You can question whether the world needs casinos or cruise ships. But the country absolutely needs a leading-edge aerospace company that can build airliners, along with all the other military and space-related talents that are resident in Boeing.

The problem is… The country does NOT need to bail out bad management teams, let alone subsidize the Wall Street ethic about how the profits belong to the traders and bankers.

And as I explained in my Feb. 6 article, Boeing is truly the poster child for shockingly bad management.

Among its many sins, the company spent about $100 billion in the past 10 years buying back its own stock.

That is, Boeing used the massive profits it was bringing in to purchase shares in the open market. Share buybacks are exactly how Boeing’s price touched $440 back in February 2019, mere days before the second crash of a B-737MAX. (Now shares trade under $100, a plunge near 80%.)

Boeing share buybacks.

In other words, Boeing paid out nearly all the cash it was — and I mean “was” —raking in from the fast-expanding global aviation market. Those dollars rolled right out as share buybacks and dividends.

Meanwhile, Boeing skimped on research and development. It failed to come up with a next-generation aircraft to replace its venerable B-737, opting instead for one more stretch that became the ill-fated B-737 MAX.

It’s had other problems at the operational level, too, including shoddy work on the Air Force KC-46 tanker program, such that the U.S. government stopped accepting deliveries. And more issues the relatively new B-787, as well as with Boeing’s work on space programs.

In my experience, Boeing has an army of great people. Talented engineers and factory floor workers. They know how to build airplanes.

Boeing’s problem has been its senior management, ensconced in a skyscraper in Chicago, far from factory floors across the country.

While cash flowed in, management failed to fully to address the internal issues of designing, building, delivering and supporting aerospace-grade products. It didn’t even build up a large bank account of retained earnings. Instead, to borrow Ed Bastian’s viewpoint, Boeing’s board and managers apparently believed that the company’s profits somehow belonged to Wall Street.

Of course, Boeing isn’t the only company guilty of prioritizing share buybacks over growth…

Share buybacks are an odd business concept. A company uses its own money to support its share price.

All that buying action makes the company – and its shares – look strong and attractive. It might even make management look smart.

But it’s just a trick. The process merely enables more and more shareholders to sell more and more shares at a relatively higher price than if the company wasn’t buying. Share buybacks create a fake valuation for any company.

And here’s the truly nutty thing about buybacks…

Wall Street tells us that buybacks “return money to shareholders.” That’s what However, when a “shareholder” sells shares, he/she is no longer a shareholder — or at best, is a shareholder with a smaller stake in the company. Why is this somehow a good thing?

Share buybacks transform shareholders into former shareholders, letting them walk away with a sweet farewell gift… with what used to be company cash.

One argument for buybacks is that they reduce share count over time, allowing the same amount of earnings to look better in a per-share sort of way. It’s called “financial engineering.” But I call it pure sophistry…

For example, take a billion dollars of earnings and apply them over a billion shares. That’s one dollar of earnings per share, right?

Now, buy back 100 million shares, leaving 900 million out there. So that same billion dollars of earnings is now spread over 900 million shares, for $1.11 of “earnings” per share.

In other words, by buying back shares, management supposedly just “increased” earnings by 11% per share. Again, though, it’s just a simple math trick. Same numerator. Smaller denominator.

Management didn’t increase earnings at all —yet they can boast about how much better the “per share” metrics are on their watch!

Meanwhile, where’s the cash? Gone!

And that brings us to today…

No one could have predicted the coronavirus outbreak even six months ago. The bug came out of the blue.

Still, everybody knows that there are business cycles. Good times come and go. Or as the saying goes, “Nobody rings a bell at the top of the market.”

In the present case, in a matter of literally a couple of weeks, the U.S. went from a booming economy to what many are calling the beginning of the next Great Depression. The rest of the world is not far behind.

And the government interventions have already begun.

According to President Trump, “Yes, I think we have to protect Boeing. We have to absolutely help Boeing.”

Trump knows that America’s aerospace industry supports over 2.5 million jobs and 17,000 suppliers. Right now, the country is staring at disaster; the near-collapse of an industry in which America leads the world, and loss — perhaps destruction — of many of the jobs and economic benefits that it creates.

Boeing’s wants government financial support “to manage the pressure on the aviation sector and the economy as a whole.” Boeing is, in effect, promising to use government largesse to protect aerospace jobs and companies in the supply chain.

Taken as a whole, the U.S. government must strike a balance. There’s the need for some semblance of sanity in fiscal and economic policy, versus the potential of utter chaos from mass unemployment, a collapsing aerospace and air transport sector and likely damage to national security.

The question is how to keep it afloat. Finance Boeing with government funds? Or let the company go bankrupt?

Now may not be the time to get “too” creative; but why not both?

That is, break up Boeing into a commercial airplane builder, and turn what’s left into one or more companies in the defense sector (which are more like public utilities anyway). If it takes a bankruptcy proceeding to clear legal obstacles and eliminate debts, then so be it.

Bankruptcy is a legal status. For Boeing, the real estate, hangars, construction sheds, tools, equipment, intellectual property and more remain. And the workforce will generally stick around, if there are paychecks.

The company (and the country) also needs many of the mid and “sort of” upper managers at operational levels — the folks who know how to run an aerospace company. That will stay true whether their paycheck comes from Boeing or a new business entity with a different name.

It’s Boeing senior management and the board that ought to go. Replaced by people who have a mandate to keep Boeing together, build airplanes and all but spit in the eye of Wall Street demands for dividends and share price moves.

That is, any government bailout money must come with plenty of strong strings attached. Break up Boeing so that it’s no longer too big to fail. No dividend for the duration of the current crisis. No money ever for share buybacks. No large compensation packages for any executives of inside players.

Other bailouts should follow the same formula. The money has to stay with the company until whatever new system evolves out of the current mess. The country is in a crisis. We may as well fix a few things while we’re cleaning house.

Wall Street may not like it… but tough. That money, as Ed Bastian rightly states, isn’t theirs.

On that note, I rest my case.

Best wishes,

Byron King

Byron King
Managing Editor, Whiskey & Gunpowder
WhiskeyAndGunpowderFeedback@StPaulResearch.com

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Byron King

A Harvard-trained geologist and former aide to the United States Chief of Naval Operations, Byron King is our resident gold and mining expert, and we are proud to have him on board as the managing editor of Whiskey & Gunpowder.

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