Business Day

Stock Buyback Plans, Seen as Shareholder Boon, Can Backfire

Fair Game

By GRETCHEN MORGENSON    MARCH 11, 2016

Stock buybacks are a boon for shareholders, right?

That’s been the spin, anyway, as hedge fund activists have pushed corporate managers to spend billions repurchasing shares in recent years.

But not all buybacks are created equal, and exhibit A is LPL Financial Holdings, a brokerage and investment advisory firm in Boston. LPL recently completed a $275 million stock buyback spree that was exceedingly costly, increased the company’s debt and wound up primarily benefiting a powerful insider investor.

Shareholders typically like repurchase programs because a company’s earnings per share rise as the number of its shares outstanding falls, often propelling its stock price. These purchases can also support a company’s stock when the overall market is in decline.

Share buybacks are on a tear so far this year. Authorizations are up 41 percent through Feb. 11 from the same period last year, according to Birinyi Associates, a stock market research firm. Financial companies are among the bigger players in the buyback market right now.

But as LPL Financial’s recent buybacks show, there are pitfalls aplenty in these transactions.

LPL is the nation’s largest independent brokerage firm, supplying investment technology and advisory services to 14,000 financial advisers across the country. Founded in 1989, the firm sold a majority stake in 2005 to two private equity giants, Hellman & Friedman and TPG Capital.

In 2010, LPL sold stock to the public for the first time at $30 a share. After the initial offering, the private equity firms held 63 percent of the company. Three years later, Hellman & Friedman exited its investment, distributing its LPL holdings to its investors. TPG kept a stake in the company and two seats on the LPL board.

LPL has struggled lately. In May, the Financial Industry Regulatory Authority sanctioned the firm for supervisory failures related to its sales of certain exchange-traded funds, real estate investment trusts and annuities. LPL paid a $10 million fine and $1.7 million in restitution to customers; it neither admitted nor denied the accusations.

In late summer, with LPL’s stock lagging, Marcato Capital Management, a $3.5 billion activist hedge fund overseen by Richard T. McGuire III, came knocking. Mr. McGuire started his company in 2010 after a stint at Pershing Square, a hedge fund founded by William A. Ackman.

In recent years, Marcato has rattled corporate cages at NCR, a technology company, and Lear, an auto parts maker, prodding the companies to change their capital structures.

On Sept. 21, Marcato disclosed in a regulatory filing that it had been buying LPL shares and owned about 6.3 percent of the company. Marcato had amassed the six-million-share stake, it said, because it thought LPL’s shares were undervalued; it said it might discuss ways to enhance shareholder value with management.

LPL stock closed at $40.20 that day, a 3 percent rise. A little over a month later, on Oct. 29, LPL announced that it was going to “maximize shareholder returns.” The chosen formula was to amend its credit agreement to allow for an additional $700 million of borrowing and buy back $500 million of its own shares. The stock closed at $42.91 that day.

The company moved quickly to execute the buybacks. By Dec. 10, LPL said it had completed an accelerated plan, repurchasing $250 million in stock, or 5.6 million shares. Its average cost a share was about $44.50, the company said.

But instead of going into the open market to buy the stock, LPL repurchased 4.3 million shares from TPG, the private equity firm and partial owner. That meant more than three-quarters of LPL’s $250 million buyback spending went to TPG.

Although TPG still owned 8.6 million LPL shares, the transaction allowed the firm to dispose of about one-third of its stake at what turned out to be a very sweet price.

LPL declined to answer my questions about the buyback, including those about how its board had determined that buying back TPG’s shares was the best way to execute the repurchases. In regulatory filings, the company said neither of the TPG-affiliated directors had participated in approving the LPL buyback. The company also said TPG approached Goldman Sachs, the company LPL had hired to execute the repurchase.

On Jan. 14, Marcato disclosed that it, too, had jettisoned some of its LPL shares, reducing its holdings to 4.9 percent from 6 percent. By then, LPL shares had fallen to around $36.

Disaster struck on Feb. 11, after the stock market closed. LPL disclosed fourth-quarter and year-end 2015 results, with profit falling 35 percent in the quarter and 5 percent for the year. The company cited extreme market volatility as the main factor behind the woes.

In the disclosure, LPL noted that it was still buying back shares. As of Feb. 11, it said it had paid an average of $39.41 for 630,000 shares.

Those purchases and the earlier ones looked unfortunate indeed when LPL’s stock collapsed to $16.50 the next day. It has recovered a bit to $22.42 now.

But the damage had been done. In an attempt to enhance shareholder value, LPL increased its debt to buy back shares. Then the stock collapsed to less than half the price it had paid to repurchase those shares. And the biggest beneficiary of the buyback was TPG, a private equity firm with a stake in the company. TPG declined to comment.

Marcato, the hedge fund that appears to have instigated LPL’s recent stock buyback, reduced its stake, too. The fund did not reply to an email seeking comment about its investment in LPL.

Given that its stock is in the cellar, now would seem to be the time for LPL to ramp up its repurchase program, offsetting some of the high prices it paid in past transactions. From early 2013 through April 2015 — well before the latest round — the company bought back almost $300 million of stock at prices between around $42 and $52, regulatory filings show.

The company, though, now has less cash to devote to such a buyback plan.

So-called hedge fund activists have made a habit of swooping into companies they see as vulnerable and demanding changes to their capital structures. Stock buybacks are a popular page in these funds’ playbooks.

But as the LPL Financial story shows, these tactics may not wind up helping shareholders at all.

A version of this article appears in print on March 13, 2016, on page BU1 of the National edition with the headline: A Buyback That Stung Shareholders.

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