After market close on Friday, Facebook (NASDAQ: FB) surprisingly announced that its board of directors had approved a $6 billion share-repurchase program. While the authorization obviously puts the spotlight on the large stockpile of cash the social network has accumulated since its initial public offering in 2012, it also sets a precedent for what could turn into a regular, significant share-repurchase program.
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Image source: Facebook.
In other words, Facebook could very well end up not just buying back $6 billion shares, but rather tens of billions of dollars' worth of shares.
Why repurchase shares?
It's first worth clarifying why Facebook might want to repurchase its own shares.
In theory, share repurchases reduce a company's total share count and subsequently increase intrinsic value per share. This is why share repurchases are often thought of as an alternative to dividends for returning cash to shareholders.
But in reality, it doesn't always work out this way. The main roadblock to an ideal outcome for share repurchases is overpaying for shares. In other words, if a company buys its own stock when it's overvalued, it's gaining less per-share intrinsic value than it's spending, essentially reducing overall intrinsic value.
Overpaying or not, repurchases typically represent a vote of confidence from management in the long-term potential for a company's stock.
Facebook's repurchase program seems intent on not overpaying for its own stock. Without an expiration date for the authorization, and with price being one of the factors the company says will influence the timing and actual number of shares repurchased, management looks positioned to at least try to exercise repurchases in an opportunistic manner.
A growing stream of cash
With this $6 billion repurchase program representing only about 1.8% of the company's market capitalization, some investors might brush off these planned buybacks as unimportant. But what if $6 billion was only the beginning of Facebook's stock buybacks? Even more, what if it was only the tip of the iceberg?
As Facebook begins spending billions of dollars buying back its own shares, investors should realize that there's plenty of more cash where this came from. Not only does Facebook now have an impressive $26.2 billion in cash and cash equivalents on its balance sheet, up from $18.4 billion one year ago, but the company also boasts substantial and rapidly growing cash flow.
In Facebook's most recent quarter, the company raked in $2.5 billion in free cash flow, up from $1.4 billion in the year-ago quarter. At $2.5 billion in free cash flow today, this puts the company at an annual run rate of $10 billion in free cash flow. And this is a conservative projection, considering Facebook is still growing at a breakneck pace measured by almost any metric.
Given that Facebook's ability to accumulate cash should only increase in the coming years as the social network continues to benefit from marketers' growing advertising spending on mobile devices, the board's authorized $6 billion for repurchases could very well turn into much more than an isolated event.
I think it's more likely that a $6 billion buyback program is the beginning of consistent (and hopefully well-timed) buybacks for years to come.
Still, even if this is just the beginning of a consistent repurchase program for the company, it may not necessarily help reduce the company's share count. In light of the company's rapidly increasing share-based compensation, even a $6 billion program may only be enough to only offset share dilution from compensation.
Facebook's share count may not actually decrease
Facebook's annual share-based compensation hit about $3 billion in 2016, up from $217 million in 2011 and $1.84 billion in 2014.
With share-based compensation like this, Facebook will need big repurchases to help offset resulting dilution.
That said, whether Facebook's repurchase program ends up only being enough to offset dilution from share-based compensation or goes further and helps reduce total share count, chances are the program is here to stay -- and as long as shares are repurchased at a good price, the buybacks are worthwhile.
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