You are a Technology company CEO and/or Board member and the company generates significant free cash flow. You are thinking through your options as to how best to deploy discretionary capital:
1.) M&A: Our advice is go for it. M&A is rarely easy for a variety of reasons but a disciplined approach can result in a positive ROIC rather quickly. Further, M&A can augment or almost entirely replace (speaking from experience) organic product development. There aren’t any shortcuts to effective M&A execution. Assuming two parties agree on strategic fit and are willing to engage, rigorous due diligence is the only way to ensure product/ technology stack fit, cultural fit, financial health of the target etc.
2.) Pay a Dividend: The optimal way to return capital to shareholders.
3.) Invest in New Product Development: Whether it is an ambitious technology re-write, product refreshes or small dollar experimentation – it is difficult to argue with a technology company that wishes to invest in its product portfolio.
4.) Stock Buybacks: Skip them. Buybacks/ share repurchases have been in vogue with I-Banks and companies for the past decade. Bankers like buybacks because they generate fees. Shareholders like them because they prop up the stock and provide liquidity. Companies like them because they prop up the stock, their large shareholders often recommend them and they reduce options dilution. We don’t like share repurchases because they represent an undisciplined approach to providing liquidity to shareholders. Further, once shareholders and companies get hooked on share repurchases, it is difficult to find discipline. John Malone says it succinctly with his cookie consumption analogy: