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Which One is Better Utilization of Cash Reserve By Companies - Buyback Vs. Acquisition

On Global level, many of the corporate are generating huge cash flow from their existing business. It's a universal truth globally that business dynamics are so volatile that no one can be assured of good days all the time. I must remind the time of Enron bankruptcy, WorldCom meltdown, General Motors, IBM PC & Server Business, Nokia, Alcatel, Sun Microsystem and More recently Yahoo whereas Facebook, Google, SnapChat, Uber and many other took the center stage.

Most of the above company who went underwater or faced heavy financial crisis and forced the government to intervene and helped them financially to secure millions of associated job. At the same time, we all are aware about that during the bubble time, these companies made many of their employees billionaire.

There is a trend of stock option which companies offer to their employees to retain them but ultimately dilute the share more. It impact companies Earning per share in negative way. In today's business environment, listed companies are under tremendous pressure to meet the earnings growth forecast else their major chunk of market share gets wiped out when sell off post dismal result.
Given above circumstances, I want to discuss about the effective way to utilize the cash reserve by the companies.

Buyback - Companies announce buybacks to buy their own share from the open market. It reduce their floating share in the market and ultimately impact the earning per share on the positive side. Many companies like Cisco, HP, Dell , Sun Microsoft, Nokia did in the past and literally pumped in billions of $ to ensure that they meet their EPS. What these companies are buying is nothing but the additional share which goes to market when their vest out their stock option. On the actual level once the number of floated share goes higher these companies goes for buyback. The money is spent but companies are not adding any additional revenue source. In case downturn happens then they get trapped in financial problem.

In Acquisition, Companies buys out competitor or companies from different segment to diversify their portfolio. It add revenue stream to company bottom line which in fact help company to meet EPS even though floating share goes up post stock option initiated dilution. I want to give an example of Oracle which acquired regularly and superceded many companies. At the same time, they continue to increase their revenue and free cash flow and cleared out even their debt which they took in some big acquisition

Microsoft announced $40 Billionbuyback at a time when their share price is running at $57 plus per share and the market cap of around $447 Billion. In that scenario, they can only reduce 9 to 12% of the floating share. On a contrary look at their acquisition of Linkedin in $26 Bn and we should be aware that Linkedin posses huge potential of generating high margin operating profit and cash flow.
It's nothing but to make street happy and meet EPS online so that Stock Option holder dont lose money

Sources: Market watch

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About Devendra Prasad

20 years plus industry veteran of domestic and international ICT domain with the expertise in Business, Technology, Strategy and Analysis. Specializes in forecasting impact analysis, trends and recommendations for Investments, Technology and Regulations.
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