DEBUNKED: Southwest’s Meltdown Wasn’t Caused By Government Subsidies Being Used For Share Buybacks

There’s a rather odd take on the Southwest Airlines meltdown, that it was caused by capitalism or, in Senator Bernie Sanders’ formulation, caused by stock buybacks to benefit shareholders at the expense of passengers.

Corporate greed is Southwest getting a $7 billion bailout during the pandemic & spending $5.6 billion on stock buybacks to enrich wealthy shareholders, while stranded passengers are threatened with jail time for the crime of trying to rebook canceled flights during the holidays.

— Bernie Sanders (@BernieSanders) December 29, 2022

I mean, Bernie voted for an airline bailout and he surely knows that taking Payroll Support funds included a prohibition on share repurchases. Now that the restriction has lapsed, and airlines generate cash from their business, they’ll do buybacks again. However the reference here is to stock buybacks that occurred before the bailouts so he’s being pretty disingenuous.

But there’s an important point here.

  • Southwest Airlines needed to make more investments in its infrastructure
  • And should have done that with excess cash, indeed they didn’t really have ‘excess cash’ without having made those investments
  • Funds would have been better spend addressing their IT capital deficit

But none of this actually has anything to do with buybacks. Buybacks aren’t the reason Southwest didn’t accelerate IT spend. We know this because they had the strongest airline balance sheet going into the pandemic. While they could have financed needed investment with cash that was used for buybacks, they could also have made those investments even while doing buybacks. It was simply a management error not to do so, unrelated to buybacks

Let’s not misunderstand what buybacks even do. “Enrich wealthy shareholders” is far from the correct framing.

Businesses with cash that they can’t productively invest to earn high rates of return should not be holding that cash. They can pay dividends or buy back shares. Buybacks are more tax-efficient. The money then gets invested in companies that have a better opportunity to earn returns. And it is better to transfer assets from low return businesses, back to shareholders to invest in higher social return opportunities. Stock buybacks are completely misunderstood.

  • When airlines generate cash that belongs to shareholders they can invest it or return it. Airlines are generally low growth businesses, and there are usually better opportunities for investment outside the airline. So dividends/buybacks move the cash to more productive places – that is good for society because it means money invested in productive, innovative businesses.

  • Buybacks, though, don’t even generally raise share price in a materially lasting way. Share price includes the cash held by the company. When they distribute the cash the airline has a lower value, because they have less cash. They also have fewer shares.

  • Stock buybacks literally cannot make shareholders wealthier. The cash held by the company already belongs to the shareholders. It is in the company’s account. The company distributes the cash. The company is worth less, moving the cash from its balance sheet over to shareholders (who invest it elsewhere).

  • Buybacks have historically been more tax-efficient than dividends though of course there will now be a 1% tax. No one seems to complain about dividends even though they’re basically the same thing for the company (but many investors prefer them for tax-efficiency).

So what possible benefit can there be to the company? Why do analysts get excited by buybacks? Buybacks might trick investors by making per-share numbers look better, but ‘tricking investors’ is the opposite of what Sanders is concerned with.

Buybacks might briefly increase demand for shares so there might be a temporary trading bump. There may (on rare occasion) be some self-service here on the part of executives timing their own awards and sales. But that’s about executives taking advantage of shareholders, again where shareholders are the victim.

And buybacks can signal confidence in the business’s prospects, since they do not need the cash. That’s former American Airlines CEO Doug Parker describing the company as effectively an annuity, generating an average of $3 billion in free cashflow each year, and promising they’d ‘never lose money again’. Again, fooling investors!

Whether a business is holding sufficient cash to operate is ultimately a reasonable question. Whether they’re investing their cash well and growing where they have opportunities, is important for boards to consider when evaluating management. As an issue for a Senator, however, it’s ill-informed nonsense.

An honest anti-buyback take would be to acknowledge that the federal government has created an implicit commitment to continue to bail out airlines when needed (Delta’s CEO has spoken explicitly to this saying “we’ve proven that governments will be there for us if ever needed again”) and therefore requiring airlines to hold greater cash reserves to forestall this might make sense.

In other words, Congress might have to require airlines to hold cash because Congress itself is dysfunctional and can’t resist shoveling taxpayer cash into airline coffers. Of course breaking the commitment that airlines can pick taxpayer pockets would be the better approach.

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