Sarine Technologies Ltd – Clockwork buy back

There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds — cash plus sensible borrowing capacity — beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated.
— Warren Buffett, 2000 (read here)

As I read in details the history of Sarine Technologies Ltd. I found something interesting.

1) Firstly, with regards to the 24% drop in share price on 13 April 2015 due to Sarine’s disclosure on 12 April 2015 on its profit guidance that its revenue for the first quarter of 2015 “were impaired by around 50% as compared to the same quarter in 2014”, this seems to be a repeat on 23 Dec 2014 when Sarine announced in its Q3 2014 report that “the diamond industry, is likely to continue to be, during Q4 2014 and early 2015, adversely affected by credit shortage, increase in polished diamond inventories and the divergence in the prices of rough stones and polished diamonds”. (read here)

If we look even further back into history: On 30 Aug 2012, Sarine stated in its report titled “Rough Market”, that “De Beers Cuts Prices by an Average of 8%”.

2) In all these 3 occasions, like clockwork, right after the announcements were made, Sarine’s share prices dropped. The recent share prices drop in Dec 2014 and April 2015 were especially pronounced, probably given the elevated share prices. And interestingly, right after the share prices dropped, Sarine’s management started shares buy back. See below:

 

Back to Warren Buffett’s year 2000 quote earlier (read here).

According to Warren Buffett, a company can add value to its shares by buying some of them back:

1. where it has surplus funds;
2. where it can buy them back at a price below intrinsic value.

For the first requirement: Without doubt, with 45.497mil cash and zero debt, Sarine Technologies Ltd has adequate liquidity.

The second requirement is that the stock must be selling for less than its “conservatively calculated” intrinsic value. As Sarine operates in a cyclical business and diamond cost are primarily driven by emotions, it is difficult to calculate the intrinsic value of the business. In addition, as the international market leader in diamond technology, it is hard to gauge Sarine’s future business prospects and stock price in comparison to those of its competitors. Approaches to determining stock values vary but fundamentally each company judging itself undervalued is saying that its future stream of earnings justifies a higher price than the stock market is willing to accord it.

As mentioned in my earlier post,  base on the P/E (26.49), Price/Book(8.60), Enterprise Value/EBITDA (ttm) (22.65), Sarine’s shares would no doubt appear expensive.

However the key word here is intrinsic value and it is tied to earning’s growth. If we are to base on the historical earning growth rate of Sarine, the current stock price will appear undervalued (as compared to the intrinsic value).

However, Warren has also criticized share buy back:

“Now, repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason, to pump up or support the stock price. The shareholder who chooses to sell today, of course, is benefited by any buyer, whatever his origin or motives. But the continuing shareholder is penalised by repurchases above intrinsic value. Buying dollar bills for $1.10 is not good business for those who stick around.” Warren Buffett 1999

When a company has spare cash on its balance sheet that it does not need to invest in its business, it can use share buybacks to boost its earnings per share, and this is what Sarine is doing. Buybacks have also come under criticism because they are regarded as a way to improve management benefits under share option or other remuneration schemes that relate to an improvement in earnings per share.

I have noticed that Sarine practices Grant of Employee Share Options (notably in 19 Jan 2015, 11 May 2014, 30 Apr 2014, 02 Mar 2014, 27 Feb 2014, 30 Apr 2013, 18 Feb 2013). And in the year 2014, of the 3.81 mil stock options issued, 2.62 were exercised.

After years of lucrative stock option programs, a company may feel the need to repurchase shares to avoid or eliminate excessive dilution.

There is also an issue of bonus share on 31 May 2012.

As stated by Warren: CEOs and other top managers exercised their stock options, then immediately sold the resulting shares, throwing millions of new shares into the market. To keep that glut of new stock from diluting the market price, companies bought back massive quantities of shares — typically at just the moment when they were ridiculously overpriced. (read here)

The saving grace is that Sarine did not buy back shares when the shares are ridiculously over-price (rather at dips right after they announced the bad news – with the recent purchases during huge dips eg. more than 20%). And it does so with clockwork precision (frankly I think the management of Sarine can predict the stock prices of its stock or fear in the market, better than most people or analysts, although the price drop can seem a bit manipulated). So I reckon it (stock buy back) is not for the purpose of fattening the wallets of the management. And it seems that the management is very confident of the future prospect of the business (although the problems of rough & polished diamond price difference, India credit issues & emergence of China as the dominant market etc has been persisting for some time, and may not be resolved in the near future, nor are the solutions entirely within Sarine’s management’s control).

Nevertheless, judging by the past buy back actions from Sarine management, and the historical earnings growth (not to mention share price growth), it seems that the management knows what they are doing. And frankly, if the business is indeed growing (in the long term), I much prefer management to use the excess cash to buy back stocks rather than issue out as dividends (as I think they – the Sarine Management, can repurchase stock better than I do :p).

However, these actions require further examination and monitoring, as Sarine may be merely using buybacks to prop up ratios, provide short-term relief to an ailing stock price or to get out from under excessive dilution (due to excessive stock options to its employees).