Exelis CEO David Melcher said he expects US defense companies to start slowing down their practice of share repurchases around 2015. (Staff)
WASHINGTON — The recent surge in share repurchasing and dividend increases will slow in the next couple of years as companies get involved in the merger and acquisition market and invest in critical technologies, Exelis CEO David Melcher said on Wednesday.
Melcher, speaking at the Atlantic Council, said that while spending cash directly on shareholders has been popular as a means to maintain investor interest, that can’t continue indefinitely. In a chart he presented, he estimated that the slowdown will begin around 2015.
“While shareholders will tell you that they like share buybacks because its constantly increasingly EPS [earnings per share], there’s only so many shares to buy back,” he said. “Unless you’re going to go private, at some point you’ve got to figure out how to have a better allocation of your capital to find ways to grow the business other than financial.”
Melcher also pointed to the rapid growth of dividends by defense companies. In some cases, a combination of dividends and share repurchasing is eating up more than half of companies’ free cash flow. Northrop Grumman is working on buying back 25 percent of its stock, and a 2011 Defense News analysis found that dividends had increased by more than 70 percent over the preceding five years.
“Some defense companies are leading, they’re not quite as high as utilities maybe, but they’re getting pretty close in terms of the dividends that are being paid to shareholders now,” he said.
Those techniques have attracted investors despite the cuts to defense spending, as seen by record stock prices. But when merger and acquisition (M&A) activity picks up, as many in the industry expect as future budgets become a tad more predictable, Melcher said he expects companies will reconsider the approach.
“There’s really not much M&A going on, so this is the best use of cash in the eyes of the shareholders and the management right now,” he said. “I think that will lose a little steam as we begin to see this whole era played out, and we’ll see more companies begin to invest in the things that they think are required for the future.”
Defense Department officials have been adamant that they’re not amenable to M&A activity among the few primes that survived the 1990s downturn, but more mid-tier activity and vertical integration would likely get the green light.