Essay on Stock Buybacks and Asset-Lite Management
The Boeing Buyback
He that maketh haste to be rich shall not be innocent.
The concept of ‘earning power’ expressed as a definite figure and the derived concept of intrinsic value as something definite and ascertainable cannot be safely accepted as a general premise of security analysis.
As capital flow analysts, we generally focus on ‘big picture’ information – macro flows compiled by the Federal Reserve Bank, with background on taxes, government policy, demographics, and sociological trends.
Sometimes, however, it is useful to check conclusions by examining individual companies. Such anecdotal evidence helps validate hypotheses derived from macro data.
To corroborate the connection between asset-lite management and stock buybacks, we will look into the history of the Boeing Company during the final years of the Great Bubble.
Boeing was chosen for this examination because Joseph Albaugh, President (Space and Communications) of The Boeing Company, spoke at the AIAA Global Air and Space Conference on May 11, 2020 , at the apex of the Great Stock Bubble, reminding fellow executives of the significance of asset-lite management, and because Boeing was not, at the time, known for management misbehavior.
Inherently Asset-Lite Business
Boeing was selected for study because, as representing American big business at the millennium, the company was reputable and unsullied by financial scandals.
Mr. Albaugh, who subsequently became president and CEO of Boeing and a presidential advisor during the Bush administration, said at that time:
First if you look at business today, businesses are not rewarded for asset-heavy endeavors. … Today businesses are rewarded for transforming raw information into usable data … and for increasing the efficiency of so-called transactional activity – searching for information, coordinating events, and monitoring performance. This kind of business is inherently asset-light and it's very different from many of ours.
(‘Aerospace Management Challenges of the Next Century’ Joseph Albaugh)
In May 2000, Boeing was the world’s largest producer of commercial jets and satellites and one of the largest military aircraft contractors.
The company was at the tip of the spear of America’s industrial power and technological prowess – the maker of the Boeing 747, the Space Shuttle, the 18-E/S Super Hornet fighter jet, the Delta rocket launch vehicles, the satellites used in the Global Positioning System, many parts of the Space Station, and other impressive hardware.
Boeing represented the best in American industry – one of the few remaining manufacturers of products in which the United States retained a favorable balance of trade.
Boeing was a vital part of what President Eisenhower called the ‘military-industrial complex’.
Its connections to the nexus of power in Washington were impeccable. There was a revolving door and Old Boy Net involving company directors, executives, employees, and the Department of Defense, the U.S. Military, NASA, Congress, famous universities, and other large corporations. Boeing had over 160,000 employees.
Boeing's Board of Directors
In 2001, Boeing’s board of directors was made up of figures from the very apex of American society. Ex-government people included:
-
Kenneth M. Duberstein (White House Chief of Staff, 1988-89),
-
John M. Shalikashvili (Chairman of Joint Chiefs of Staff, 1993-97 and Supreme Allied Commander NATO), and
-
Rozanne L. Ridgway (32 years with the U.S. Department of State, including as Assistant Secretary of State, 1985-89).
Three members of the board had been CEOs of other blue chip companies: Minnesota Mining and Manufacturing Company (3M), Hewlett-Packard Company, and Edison International.
Two directors were long-time senior executives of Boeing.
Institutional investors were represented by John H. Biggs, Chairman President and Chief Executive Officer of the Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF).
As discussed in the essay on Corporate Governance, Mr. Biggs, through TIAA-CREF, was a leading spokesperson for corporate governance, strongly favoring ‘competitive remuneration’ for company executives and options as a way to link management pay to stock prices.
Boeing was listed on the New York Stock Exchange. In April 2003, its shares were rated a ‘strong buy’ by Standard & Poor’s. Boeing was a blue chip stock.
-
In 2003, it had 138,000 shareholders, of which 1,700 were financial institutions that held over 63% of the equity.
-
Another 20% of the shares were held by directors, executives, employees, and other insiders.
-
Less that 20% of the capital was owned by outside, non-institutional shareholders.
In essence, the company was controlled by institutions and insiders.
About one-half of one percent of Boeing equity was traded each day on the exchange.
Space Age Accounting
The financial reports of the Boeing Company show the flexibility and imprecision of modern accounting practices.
The notes to the 2002 annual statement honestly show the acute degree to which the figures were dependent on management estimates, forecasts, assumptions, and opinions.
The company balance sheet revealed that over twelve billion dollars of assets were related to goodwill and other intangibles, such as prepaid expenses and deferred taxes.
This was 166% of shareholders’ equity.
Furthermore the notes to the statement indicated “material interests in non-consolidated entities” with total assets of over four billion dollars that might eventually need to be consolidated, while not disclosing the impact that such consolidation might have on the company’s financial position.
The company fairly and ethically disclosed that it used several different accounting methods, including ‘contract accounting’ for production of military aircraft, missile systems, and space and communications, and ‘program accounting’ for commercial airplane manufacture.
A key feature of ‘program accounting’ was the posting of expenses to asset accounts.
The sensitivity of earnings to management conjecture was duly noted. The company stated that a change of one-half of one percent in ‘program accounting’ estimates would alter earnings by one-hundred twenty-two million dollars.
Boeing's 'program accounting' featured posting expenses to the balance sheet.
The account balances for corporate assets and liabilities were highly responsive to changes in financial markets.
For example, a one-quarter of one percent fall in the discount rate would increase the company’s pension liabilities by $1.5 billion!
Even more interesting was the connection between accounting figures and the price of Boeing stock.
The notes stated that under SFAS Rule 142 for ‘good-will impairment’ a ten percent fall in the price of Boeing stock would reduce corporate earnings by one-hundred sixty million dollars.
Since the price of stock depends on company earnings, this circular relationship could lead to negative feedback between stock prices and corporate earnings – eating up future profits like a snake swallowing its tail.
In 2002, falling stock prices forced a massive $2.1 billion write-off and another $1.2 billion in the first quarter of 2003.
An Auditor's Limited Opinion
Although accounting rules resulted in earnings being exceedingly susceptible to management’s approximations and to swings in interest rates and stock prices, the auditors, Deloitte & Touche, gave no hint whether these estimates were aggressive or conservative.
They merely said that “financial statements are the responsibility of the Company’s management.”
The auditors did ‘assess’ management estimates but only to certify that the statements presented fairly, in all material respects, the financial position of the company and its subsidiaries “in conformity with accounting principles generally accepted in the United States of America.”
The investor is left to decide what to make of the numbers and whether ROE and other performance indicators are meaningful.
In 2001 Deloitte & Touche received over twenty-eight million dollars for services provided Boeing – almost five percent of dividends paid to shareholders.
Boeing's Return on Equity
CEO Albaugh’s speech in May 2000 placed Boeing in the asset-lite camp. Indeed, since 1997 when Boeing merged with its competitor, McDonnell Douglas, the company’s ROE improved considerably, rising from 8.9% in 1998 to a high of 25.9% in 2001.
In 1995, before the merger with McDonnell Douglas, ROE had fallen as low as four percent.
To the casual observer, Wall Street seemed to respond to this sign of efficiency; the price of Boeing stock doubled, rising from about thirty dollars in mid-1998 to over sixty dollars by the end of 2000.
The next two graphs show the evolution of Boeing’s key financial ratios during the years 1993-2002.
Considering that neither earnings nor sales had increased one hundred percent in the two years 1999-2000 when stock prices doubled, there must have been something else driving prices.
Despite soaring stock prices, company balance sheets had not improved. Boeing enhanced ROE by substituting debt for equity, increasing leverage and risk.
-
The percentage of long-term debt to capital rose from about 33% in 1998 to 62% in 2002.
-
The current ratio fell from a high of 1.8 in 1996, to a low of 0.8 in 2001, indicating that the company had polished its ROE by depleting liquid assets, even getting by with negative working capital.
Directors have fiduciary responsibility to shareholders, but corporate governance codes do not specify what this means. 
