Milken on Capital Structures

I am always amazed when convicted criminals, who are banned from working in the financial world for their crimes, still have a voice which carries weight. I have noticed Henry Blodget (convicted of pumping up stocks in the dotcom boom and than talking shit about them with his colleagues through email) is the co-host of tech ticker oh yahoo. Now I see convicted criminal Michael Milken writing editorials in the Wall Street Journal. I am in currently reading the book Predator's Ball, so I gave this one a read. And so says the king of the junk bonds:

Issuing new equity can of course depress a stock's value in two ways: It increases the supply, thus lowering the price; and it "signals" that management thinks the stock price is high relative to its true value. Conversely, a company that repurchases some of its own stock signals an undervalued stock. Buying stock back, the theory goes, will reduce the supply and increase the price. Dozens of finance students have earned Ph.D.s by describing such signaling dynamics. But history has shown that both theories about lowering and raising stock prices are wrong with regard to deleveraging by companies that are seen as credit risks.

Two recent examples are Alcoa and Johnson Controls each of which saw its stock price increase sharply after a new equity issue last month. This has happened repeatedly over the past 40 years. When a company uses the proceeds from issuance of stock or an equity-linked security to deleverage by paying off debt, the perception of credit risk declines, and the stock price generally rises.

Milken seems to blaming companies for their stock buybacks (hindsight is fore sight)

The new law is also helpful for companies that made the mistake of buying back their stock with new debt or cash in the years before the market's recent fall. These purchases peaked at more than $700 billion in 2007 near the market top -- and in many cases, the value of the repurchased stock has dropped by more than half and has led to ratings downgrades. Particularly hard hit were some of the world's largest companies (i.e., General Electric, AIG, Merrill Lynch); financial institutions (Hartford Financial, Lincoln National, Washington Mutual); retailers (Macy's, Home Depot); media companies (CBS, Gannett); and industrial manufacturers (Eastman Kodak, Motorola, Xerox).

Without stock buybacks, many such companies would have little debt and would have greater flexibility during this period of increased credit constraints. In other words, their current financial problems are self-imposed. Instead of entering the recession with adequate liquidity and less debt with long maturities, they had the wrong capital structure for the time.

And his opinion on financial history:

History isn't a sine wave of endlessly repeated patterns. It's more like a helix that brings similar events around in a different orbit. But what we see today does echo the 1970s, as companies use the capital markets to push out debt maturities and pay off loans. That gives them breathing room and provides hope that history will repeat itself in a strong economic recovery.

It doesn't matter whether a company is big or small. Capital structure matters. It always has and always will.