After taking over at American Airlines, management spent $12.4 billion buying back stock over a six year period at an average price of $39.76 per share. Now they’re facing over $40 billion in debt and looking for a second government bailout this year.
At an internal Crew News session at the end of last week, a pilot asked the airline’s CEO Doug Parker if the airline is able to claw its way back, whether he’d change the way the airline is run – paying down debt instead of buying stock?
- At a macro level stock buybacks aren’t different from dividends, just more tax-efficient
- They’re actually good for society – they take money from unproductive businesses without an opportunity to invest for a strong return, and make the money available for investors to put to better use.
- But American Airlines become as much financing instrument as airline, borrowing billions of dollars while buying back billions in stock.
Parker answering the pilot by explaining his September 2017 claim that American Airlines would never lose money again, saying that he wasn’t foreseeing an event as severe as what they’re experiencing, but suggested that their financial decisions made sense against the backdrop he expected – one in which they’d even still make money in a crisis like the Great Recession (he doesn’t explain why, but it’s the credit card revenue not the flying).
He then suggests they made billions of dollars in profit, and invested heavily in the company from aircraft to facilities, and then they had money left and bought back stock. He says they borrowed for the aircraft “because it was really efficient borrowing.”
Despite profits, though, American Airlines had negative free cash flow. They were borrowing money and giving cash to stockholders. They were in effect buying back their stock with borrowed money. and Parker explains it as being because interest rates were low. He turned American Airlines into a financing company that flew planes.
Before the Covid crisis American was financially underperforming the industry. They earned lower revenues for their flying (having chased away their frequent customers) and had much greater capital expenses.
Now it’s precisely that borrowed money that’s the problem, rather than the buy backs per se. The debt burden is why American is the airline with the greatest risk of not paying back its unsecured creditors. The airline has $40 billion worth of debt, even before adding government-subsidized CARES Act loans they plan to pledge the AAdvantage program as collateral in order to get.
Copyright: rido / 123RF Stock Photo
Parker had planned to pay down debt with profits if Covid hadn’t hit, and that’s what they’ll be doing going forward. He still believes stock buy backs were the right thing to do at the time, even notwithstanding the the airline’s stock price had been languishing below the price they paid to buy back stock prior to the pandemic.
His poor market timing aside, I think it’s fair to say that there’s nothing inherently wrong with stock buybacks – it’s borrowing money for buybacks which put the airline in a hole, along with heavy capital expenditures on planes and a new billion dollar headquarters.