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I have seen some excellent reasons given for the prefence or lack therof of a buy-back (repurchase) program.

I agree with those that say that buy-backs result preponderantly in better tax treatment for both the corporation/shareholder, because it avoids double taxation.

In addition, buy-backs are legitimate (and add to shareholder value) when the expected cash flow available for investments exceeds the opportunities to invest at an acceptalbe level of return. This acceptable level is called the minimum 'hurdle rate" (the AVERAGE minimum return at which a corporation is willing to invest -- The "hurdle rate should be equal to a greater than the cost of capital).

Well managed companies like Exxon, should have a cost of capital of around 10 to 12%. Since its cost of capital is composed of both the cost of equity and debt, and since the after tax cost of debt is probably about 4 to 4.5%, it is not difficult to calculate that its "cost of equity" should fall between 14 to 16 %.( Memo: the cost of equity is what it costs a corporation (either in dividends or buy-backs), yearly, to have all of those shares held by shareholders).

This 14 to 16% is almost risk free when a stock is bought back by the corporation.

What this means, is that on the Margin Exxon should invest consistently its excess cash at levels higher than 14 to 16% --given the risk element that not all investment pan out the way they are anticipated. Thus, it is easy to conclude, if one adds a 3 to 5% premium for risk ... that Exxon should invest on the margin at somewhere between 17 to 21% after tax.

The question then becomes, how many 17 to 21% after tax projects are out there. Other than perhaps in the exploration area ... there are not many.

Now, in "exploration", returns are a function of "future prices". If you expect crude prices to come down, as most people in the industry do ... then your "hurdle rate" should be caculated based on a lower price profile than the current high prices of $30/B.

Exxon has said many times that they are investing for $14/B crude level --- at this level the prospects for oil are significantly less than at $30/B. If future prices turnout to be greater than $14/B, Exxon will make more money than it planned for. If higher prices persist for a while, and become the norm, Exxon can then increase its exploration budget using its surplus cash flow if it deems that future price profile is now higher than $14/B,

So part of the reason Exxon buys back its stock is(aside from the other tax justifications mentioned) to get a better return on its excess cash than to invest in exploration programs "betting on the come" of higher prices.

Stock Buy-backs have also the added advantage that if one company does it over years, the company can accumulate a significant amount of stock that it can then use in the future to buy another, less well managed company. From 1985 to 1999 Exxon bought back 1/3 of its outstanding stock at a cash cost of about 30 billion $ ... and it acquired a company worth $85 billion $. Not bad ... in other words, the buy back program allowed Exxon to buy Mobil in sort of an installment basis, even before it new what the target company was going to be when it started its buy back strategy. Exxon just gave the Mobil shareholders essentially the market value of the stock it held in treasury, plus some cash.

Buy-backs in the current uncertain price environment is smart business ... go Exxon!

Ed
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