The new 1% corporate tax on stock buybacks included in America’s Inflation Reduction Act comes as activist shareholders are ramping up demands for companies to return capital. The levy won’t stop activists demanding buybacks according to several activist sources who spoke to Insightia. In fact, boards of directors should expect more buyback demand before the law comes into effect on January 1, 2023.
Tax time
Kohl’s launched an accelerated repurchase program to boost its struggling stock price after ending talks to sell its business to The Franchise Group. Activist investor Osmium Partners called on home décor and furniture retailer Kirkland’s to purchase 50% of its shares, arguing the business is strong and the stock is undervalued. Alta Fox Capital Management recently urged trucking company Daseke to buy back $60 million in shares following steep stock market losses.
Even Wall Street legend Warren Buffett recently faced complaints that Berkshire Hathaway didn’t repurchase enough of its own stock in the second quarter of the year.
But the growing popularity of buybacks will soon have to contend with the $430-billion Inflation Reduction Act bill which is expected to be signed into law by President Joe Biden this week.
Share buybacks have long been a staple demand of activists, as reducing the number of shares in circulation typically causes a company’s share price to rise. Fewer shares outstanding can also juice up key ratios like earnings per share (EPS).
Buyback demands in the U.S. had been on the decline for several years, partly because the bull market made it harder to argue that stocks were cheap enough to warrant repurchasing them. But following the recent market downturn and with corporate balance sheets being cash heavy, demands to return capital have been on the rise. In total, 18 “return capital to shareholder” demands have been made at U.S.-listed companies so far this year, up from 15 in the same period a year ago. This is a notable increase compared to pre-pandemic levels, with only 14 demands made in the same period within both 2018 and 2019.
“I hate stock buybacks,” said Democratic Senator Chuck Schumer in support of the new taxation. “I think they are one of the most self-serving things that corporate America does.”
Like other critics, he argues management should be investing in workers and research rather than taking artificial steps to prop up share prices by reducing the number of shares in circulation. Critics also note that senior executives often benefit personally from buybacks as their pay packages are tied to meeting share price and EPS targets.
Opponents of the new tax argue it will add another financial burden to U.S. companies already struggling with higher interest rates and inflation and make it harder for them to raise money in the future. They also note that corporate cash balances rose by almost 80% over the last 10 years, especially during the pandemic, reaching around $8 trillion.
Still cheap
With so much capital on the books and stocks at depressed prices, buybacks will remain a popular demand, according to investors Insightia spoke with. For one, they remain one of the most tax efficient ways for companies to manage their balance sheets and reward shareholders.
“At the 1% tax rate, buybacks would still be a superior means of returning capital to shareholders as compared to dividends,” noted Chris Kiper of Legion Partners.
Unlike dividends, on which investors earning over $42,000 a year pay at least a 15% capital gains tax, rising to 20% for those earning over $460,000, shareholders pay no taxes on buybacks.
That said, the new tax may encourage activists to focus their demands on companies whose stock price has fallen to the point where there is strong justification for a buyback.
“When we engage with companies on buybacks, we often are advocating for this activity at companies that have 50% to 100% upside in their share prices, and accordingly a 1% tax rate on buybacks would be very inconsequential given the significant upside in those buyback recommendations,” noted Kiper.
Where there may be an impact on buybacks from this legislation is companies rushing to get buybacks done in 2022 before the new tax takes effect. Indeed, another activist who has made multiple buyback demands in recent times told Insightia that his firm was actively “pushing” its portfolio companies to launch buybacks before the end of the year.