Having long mocked the sheer idiocy of using organic cash or worse, debt proceeds, to fund buybacks just so management can eke out a few more million in equity-linked compensation while activists enjoy a few extra points in P&L on the back of naive bondholders managing 'other people's money', we were delighted to see the buyback bubble begin to burst in the middle of 2015 starting with Michael Kors (as detailed in "When Stock Buybacks Go Horribly Wrong") and Monsanto ("When Buybacks Fail..."), when each respective stock plunged far below the average buyback price.

But nothing compares to what Hess (HES) did yesterday.

A quick recap: back in 2013, when it was trading at a discount to its peers, Hess became the target of an activist campaign led by Paul Singer's Elliott Management who demanded a quick boost in the stock price, as a result of which the energy producer decided to exit its refining business (arguably the only line of business that would have benefited from the current depressed oil price) while not only raising its dividend but also authorizing a $4 billion share buyback.

The company then boosted its buyback further with proceeds from the sale of its retail gas stations (for $2.9 billion) while growing its debt by $1 billion from 2013 to 2015, leading to the repurchase of a total of 62.7 million shares through the end of 2014 at an average price of $83.

The stock price reacted as expected: it soared past $100 from below $60 before Elliott turned up. It then continued to spend more billions under additional buyback all the way through the third quarter of 2015, which however took place just as the worst oil downturn in history was taking place. The full history of Hess' stock buybacks is shown below.

And then the stock crashed, as investors finally realized that plunging oil, sliding cash flow and surging debt meant the company found itself in a life and death fight for survival.

Which brings us to yesterday, when in an attempt to shore up liquidity and avoid halting its dividend, Hess sold 25 million shares at a price of $39/share: a 10% discount to the prior closing price.

As Reuters puts it, the "Hess folly is one for the ages."

The silver lining? Unlike before, when Hess' weak management team was kicked around by a hedge fund, at least it is being proactive now and scrambling to preserve its business even it means huge pain and dilution for shareholders.

The company ended 2015 with $2.7 billion in cash and a big revolving line of credit it hasn't dipped into yet. Capital just raised will push net debt from 5.4x EBITDA to below four times, according to Cowen estimates. That should allow Hess to keep investing in future production and pay dividends. If oil remains at $30, however, it has just bought itself a few quarters of time.

Still, that does not absolve management of pandering to a vocal shareholder: if instead of spending billions on buybacks Hess had done the right thing and saved the cash, it would not only have avoided the wild swings in the stock price which rewarded just activist investors while punishing long-term holders, and have a far bigger war chest to defend itself from $30 oil.

The bottom line: Hess just sold 25 million shares at a price of $39 after purchasing 63 million shares through 2015 at an average price that was more than double, or $83 share.

As Reuters concludes, "this modern Hess era is a case study that should be required reading in boardrooms everywhere."

Which brings us to a warning we presented back in November 2012 when we showed "where the levered corporate cash on the sidelines is truly going" and cited Andrew Lapthorne who prudently warned:

We know that buybacks are contrarian indicators, occurring at the top (and not the bottom) of the market. Why, we ask, are companies leveraging up now and not 12 months ago, when equity prices were much lower? We conclude that (contrary to what we read), US dividend payments are not enjoying a revival relative to cash flows and that buybacks remain the distribution channel of choice for corporates wishing to boost EPS and limit the effects of option dilution. Indeed, some of the biggest US names have issued debt to pay for buybacks (Home Depot, Microsoft, Amgen, Hewlett Packard, McDonalds, DirectTV, to name but a few) but there are also firms in Europe that have been doing the same (Siemens, Telenet, Adecco). In the current economic climate, you may find this surprising - we do too! A buyback in this form is not a return to shareholders - it's called gearing or balance sheet risk and will come to haunt some firms when the economy enters a downswing.

 

But can this time around be different? I seriously doubt it. When the next leg in the "structural bear market" occurs, expect the equity buybacks to end, contributing to a renewed steep downturn in bank borrowing and monetary aggregates.

For most corporations the equity buybacks have now ended (which luckily means the period of "activist investing" is now over): for some with a whimper, for Hess - with both a bang and an equity offering. The only thing missing is the realization the the next leg of the "structural bear market" has arrived.