You hear about it often. A company buys back its own stock. The right way to do this -- good for long-term holders of shares -- is called a tontine. We'll look at six tontines down below. But first, what is it?
It may sound like a French pastry, but the tontine is a legal and (non-fattening) tactic for amassing riches. We have Lorenzo de Tonti to thank for it.
Enter Lorenzo de Tonti, a banker from Naples. Tonti has an idea. "Let us have citizens invest in shares of a government-run pool," Tonti suggests. "We will pay regular dividends to them from the pool. But they cannot transfer or sell their shares. And when they die, they lose their shares. We cancel them."
Tonti continues: "We promise to pay the same amount regardless of how many shares remain. So as each shareholder dies, the remaining shareholders get more and more of the earnings of the pool. That reward will prove a great pull for investors and will raise the funds you seek."
The king stirs.
"When the last shareholder dies," Tonti winds up, "the capital of the pool reverts to the state." The king, with a wolfish grin, realizes Tonti's plan would serve his purpose. Yet even the dense king could see that the big winners of this scheme would be the long-lived holders of the shares. They would earn an increasing share of the dividends as others died off and would grow rich.
Buybacks can turn companies into tontines. As a company buys back shares, future earnings, dividends and assets concentrate in the hands of an ever-shrinking shareholder base. Many companies are doing buybacks these days, but not all are true tontines.
Tontines: Telling the True from the False for 520% Profit Potential
Since 1998, the 500 largest U.S. companies have bought back about one-quarter of their shares in dollar value, yet the actual shares outstanding grew 7%. Chalk that up to handing out the shares in lavish incentive packages to greedy executives. To work you have to actually shrink the number of shares outstanding...
But don't let the bad examples keep you away. (Especially watch out for these in the weedy thickets of the life insurance industry.) Some companies exemplify the very best of a tontine, as we'll see below.
Take AutoNation (NYSE: AN). Eddie Lampert took a stake in 2000. Lampert, a great investor, knows how tontines work. Ever since his involvement, AutoNation has bought back great gobs of stock. All told, 65% of the shares have been retired. That's 8.4% per year -- just from stock buybacks. As Steve Bregman at Horizon-Kinetics, which owns a 5% stake in AN, writes: "This is most unusual in scale and duration; one is witnessing -- or may participate in -- a slow going-private transaction that is taking place in the open market."
The effects have been wonderful for the stock. AutoNation is up 520% since the tontine began. Annualized, that's better than 15% per year -- for 13 years! The chart above shows you the past 10 years. You can see the fall in shares outstanding and the surge in the stock price.
Meanwhile, Lampert held on, and his stake swelled. He's trimmed it a bit in the past couple of years, but still owns almost 53% of the stock.
An even longer-term example is the commercial insurer Loews Corp (NYSE: L). I admire the skills and patience of the Tisch family, which controls Loews -- and is its largest shareholder. Loews loves buybacks. Over the past four decades, Loews cut share count by more than 70%. Every dollar invested in Loews in 1961 is worth about $1,240 today.
The movie studio DreamWorks (Nasdaq: DWA) has the makings of a tontine. It has retired 28% of its stock since it began buying six years ago. The effects are not yet apparent in the stock price, which makes it attractive right now. Three big media moguls control DreamWorks: Steven Spielberg, Jeffrey Katzenberg and David Geffen. Collectively, they own 22% of the stock. (Note, too: Owner-operators -- naturally protective of their equity -- often pursue these value-adding strategies.)
I've been following some other tontines in the making. Covanta (NYSE: CVA) has bought back about 14% of its shares. First Citizens BancShares (Nasdaq: FCNCA) just reported a 6% buyback. And in a recent deal, Howard Hughes Corp. (NYSE: HHC) reduced its diluted shares outstanding by 9%. Each of these stocks has significant insider ownership. In each case, the end result is that you own a larger share of these fantastic assets.
In a way, these companies become more valuable by losing shareholders. It sounds strange, but in essence, this is what's happening. The victors are those who simply hold on. Today, Lorenzo de Tonti would be in front of CEOs -- not kings -- speaking of the wonders of retiring shares and growing wealthy over time.