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Smart on Paper

— Mayoral candidate Steve Francis wants to introduce business techniques to city government. Uh-oh. That may mean hocus-pocus -- financial engineering. Since going public in 2001, the company Francis cofounded, San Diego-based AMN Healthcare Services, has been inflating its earnings per share by buying back its stock with borrowed money.

Savvy market analysts cock an eyebrow at such pencil pushing. They would prefer to see earnings per share grow because of improving business, not financial finagling. But revenues and earnings of AMN -- which places healthcare professionals, mainly nurses, in temporary positions -- have been going south.

The share buybacks almost certainly kept AMN's stock price from going down further than it did when the company's business went on the skids after peaking in 2002. This levitation permitted Robert B. Haas -- the Texas financier who with his associates controlled 46 percent of the stock -- to dump all his shares in late May at over $13 each. He had been jettisoning them during the stock buyback periods too. Haas had been chairman of the board; on June 10, he stepped down from the board entirely.

After a company has bought back so much stock, "an insider bailing out would not be a good signal," says Nikhil Varaiya, chairman of the finance department at San Diego State University. Varaiya has written extensively on corporate-stock buybacks. I did not tell him the name of the company I described.

David Allen of North County's Palomar Equity Research, who was told the name of the company, agrees. Haas's dumping of all his stock "does not seem to be an awfully strong endorsement of AMN Healthcare," says Allen.

In common with many investment professionals, Allen has strong reservations about stock buybacks, even when they appear to be used judiciously. Companies claim that they buy back stock "to send a signal to the marketplace that there is some value to the company that maybe the market is not seeing," says Swaminathan Badrinath, a professor of finance at San Diego State who has written with Varaiya about buybacks.

But trying to signal that the stock is underpriced can be a euphemism for reducing the number of shares to jack up earnings per share in order to artificially run up the stock. Managements are "manipulating the price of the stock," says Dennis Muckermann, a retired San Diego money manager who handles money for some private investors.

"All these MBA schools are turning out financial engineers," says Muckermann. "The temptation for these young wise guys is to take on a lot of debt and buy stock back. There might be some increase in earnings per share, but since they are young and inexperienced, they don't understand the concept of risk. It may look smart on paper but may not be smart in reality."

Companies insist that they are not buying back shares to boost their stock price, but the claim is belied by history. A rash of buybacks followed the stock market crash of 1987 and 9/11, after which there was a concerted effort to prop up the market.

Most companies doing buybacks say they are distributing excess earnings to investors, who can enjoy the stock surge that theoretically should occur. When a company doesn't distribute money it has lying around but resorts to borrowing to buy back shares, it defeats this purpose. "If the purpose is to return excess cash to shareholders, why borrow money to do it?" asks Badrinath.

Running up the price of the stock is often not the only dubious motivation for buybacks. The largest shareholders "are using other people's money to increase their own percentage ownership," says Muckermann. "As they increase their own percentage ownership, they are able to play even more financial games."

Sometimes, a company buys back its stock "because of pressure from some key shareholders who want the price of the stock higher," says Varaiya.

All these factors may have been at work in the AMN buybacks, which are startling in two respects: the magnitude of the buybacks and the magnitude of the debt taken on. When AMN went public in 2001, Haas and his associates controlled 26.5 million shares, or 65 percent of the stock. Francis had 1.2 million shares with a slug of options to buy more. Insiders received shares in the offering for $4.09 each; outside investors paid $15.

As in most initial public offerings, the stock rose, then fell. The stock leapt above $37 in 2002 but then fell to $13 that year as it became evident that things wouldn't be so rosy. Sales and earnings began reeling backwards. Revenues dropped from $775.7 million in 2002 to $629 million last year, as earnings tanked from $52.4 million all the way to $17.3 million.

In November of 2002 the board authorized the company to buy $100 million worth of its stock. It spent $73.7 million to buy 5.15 million shares. Then in October of 2003, the company made a tender offer for 10 million shares. It borrowed $145 million to do so. Thus, the company took on $145 million of debt to buy back 15.15 million shares. In its 2003 annual report, the company reported $138.9 million of debt, up from zero in both 2002 and 2001. AMN had eliminated debt with its 2001 initial public offering. In March of 2002 it had 42.2 million shares outstanding. In March of 2004 it had 28.12 million shares.

The average stock buyback is 5 percent. AMN bought back more than 35 percent. "That's a lot," says Badrinath, who had not been told the name of the company. Debt went from zero percent of the company's total capitalization in 2002 to 52 percent in 2003 and 41.5 percent last year. This year the debt has been reduced to $92.5 million. Allen predicts that it will take five years to wipe the debt off the balance sheet.

From the time of the public offering, Haas and his colleagues had been selling their stock, cutting their shareholdings in half, but by spring of this year, they still controlled 46 percent of the stock because of the share shrinkage. Then in a secondary offering in late May, the financiers jettisoned all their stock, more than tripling their money.

Thanks to stock options, Francis now has 3.2 million shares. He got 48.3 percent of the options granted at the time of the public offering and 22.25 percent last year. That's a top-heavy distribution of options. AMN stock has been trading around $16. Annual earnings are one-third what they were, but the stock is trading above its lows of prosperous 2002, thanks to the share shrinkage. The company refuses to be interviewed on the topic.

The buybacks were "an exceptionally shareholder-friendly action," says an analyst for Morningstar, Inc., the stock-rating firm. Three of seven analysts who follow the stock consider it a buy, according to Standard & Poor's, which is neutral on the stock. But the bullish analysts are probably not concentrating sufficiently on the balance sheet debt or the sell-off by the Texas financiers.

AMN has 30 percent of the so-called traveling nurse market. So does a competitor, Cross Country Healthcare. Wouldn't it have been wiser for AMN to amass that debt to put in a better computer system, or increase the pay of its traveling nurses, or in other ways make itself a better company?

The machinations have helped Francis politically. The Reader's Matt Potter reports that Haas, Haas's Dallas partner, six major shareholders and officers, and the company's Connecticut-based securities lawyer gave the maximum $300 to the Francis campaign.

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— Mayoral candidate Steve Francis wants to introduce business techniques to city government. Uh-oh. That may mean hocus-pocus -- financial engineering. Since going public in 2001, the company Francis cofounded, San Diego-based AMN Healthcare Services, has been inflating its earnings per share by buying back its stock with borrowed money.

Savvy market analysts cock an eyebrow at such pencil pushing. They would prefer to see earnings per share grow because of improving business, not financial finagling. But revenues and earnings of AMN -- which places healthcare professionals, mainly nurses, in temporary positions -- have been going south.

The share buybacks almost certainly kept AMN's stock price from going down further than it did when the company's business went on the skids after peaking in 2002. This levitation permitted Robert B. Haas -- the Texas financier who with his associates controlled 46 percent of the stock -- to dump all his shares in late May at over $13 each. He had been jettisoning them during the stock buyback periods too. Haas had been chairman of the board; on June 10, he stepped down from the board entirely.

After a company has bought back so much stock, "an insider bailing out would not be a good signal," says Nikhil Varaiya, chairman of the finance department at San Diego State University. Varaiya has written extensively on corporate-stock buybacks. I did not tell him the name of the company I described.

David Allen of North County's Palomar Equity Research, who was told the name of the company, agrees. Haas's dumping of all his stock "does not seem to be an awfully strong endorsement of AMN Healthcare," says Allen.

In common with many investment professionals, Allen has strong reservations about stock buybacks, even when they appear to be used judiciously. Companies claim that they buy back stock "to send a signal to the marketplace that there is some value to the company that maybe the market is not seeing," says Swaminathan Badrinath, a professor of finance at San Diego State who has written with Varaiya about buybacks.

But trying to signal that the stock is underpriced can be a euphemism for reducing the number of shares to jack up earnings per share in order to artificially run up the stock. Managements are "manipulating the price of the stock," says Dennis Muckermann, a retired San Diego money manager who handles money for some private investors.

"All these MBA schools are turning out financial engineers," says Muckermann. "The temptation for these young wise guys is to take on a lot of debt and buy stock back. There might be some increase in earnings per share, but since they are young and inexperienced, they don't understand the concept of risk. It may look smart on paper but may not be smart in reality."

Companies insist that they are not buying back shares to boost their stock price, but the claim is belied by history. A rash of buybacks followed the stock market crash of 1987 and 9/11, after which there was a concerted effort to prop up the market.

Most companies doing buybacks say they are distributing excess earnings to investors, who can enjoy the stock surge that theoretically should occur. When a company doesn't distribute money it has lying around but resorts to borrowing to buy back shares, it defeats this purpose. "If the purpose is to return excess cash to shareholders, why borrow money to do it?" asks Badrinath.

Running up the price of the stock is often not the only dubious motivation for buybacks. The largest shareholders "are using other people's money to increase their own percentage ownership," says Muckermann. "As they increase their own percentage ownership, they are able to play even more financial games."

Sometimes, a company buys back its stock "because of pressure from some key shareholders who want the price of the stock higher," says Varaiya.

All these factors may have been at work in the AMN buybacks, which are startling in two respects: the magnitude of the buybacks and the magnitude of the debt taken on. When AMN went public in 2001, Haas and his associates controlled 26.5 million shares, or 65 percent of the stock. Francis had 1.2 million shares with a slug of options to buy more. Insiders received shares in the offering for $4.09 each; outside investors paid $15.

As in most initial public offerings, the stock rose, then fell. The stock leapt above $37 in 2002 but then fell to $13 that year as it became evident that things wouldn't be so rosy. Sales and earnings began reeling backwards. Revenues dropped from $775.7 million in 2002 to $629 million last year, as earnings tanked from $52.4 million all the way to $17.3 million.

In November of 2002 the board authorized the company to buy $100 million worth of its stock. It spent $73.7 million to buy 5.15 million shares. Then in October of 2003, the company made a tender offer for 10 million shares. It borrowed $145 million to do so. Thus, the company took on $145 million of debt to buy back 15.15 million shares. In its 2003 annual report, the company reported $138.9 million of debt, up from zero in both 2002 and 2001. AMN had eliminated debt with its 2001 initial public offering. In March of 2002 it had 42.2 million shares outstanding. In March of 2004 it had 28.12 million shares.

The average stock buyback is 5 percent. AMN bought back more than 35 percent. "That's a lot," says Badrinath, who had not been told the name of the company. Debt went from zero percent of the company's total capitalization in 2002 to 52 percent in 2003 and 41.5 percent last year. This year the debt has been reduced to $92.5 million. Allen predicts that it will take five years to wipe the debt off the balance sheet.

From the time of the public offering, Haas and his colleagues had been selling their stock, cutting their shareholdings in half, but by spring of this year, they still controlled 46 percent of the stock because of the share shrinkage. Then in a secondary offering in late May, the financiers jettisoned all their stock, more than tripling their money.

Thanks to stock options, Francis now has 3.2 million shares. He got 48.3 percent of the options granted at the time of the public offering and 22.25 percent last year. That's a top-heavy distribution of options. AMN stock has been trading around $16. Annual earnings are one-third what they were, but the stock is trading above its lows of prosperous 2002, thanks to the share shrinkage. The company refuses to be interviewed on the topic.

The buybacks were "an exceptionally shareholder-friendly action," says an analyst for Morningstar, Inc., the stock-rating firm. Three of seven analysts who follow the stock consider it a buy, according to Standard & Poor's, which is neutral on the stock. But the bullish analysts are probably not concentrating sufficiently on the balance sheet debt or the sell-off by the Texas financiers.

AMN has 30 percent of the so-called traveling nurse market. So does a competitor, Cross Country Healthcare. Wouldn't it have been wiser for AMN to amass that debt to put in a better computer system, or increase the pay of its traveling nurses, or in other ways make itself a better company?

The machinations have helped Francis politically. The Reader's Matt Potter reports that Haas, Haas's Dallas partner, six major shareholders and officers, and the company's Connecticut-based securities lawyer gave the maximum $300 to the Francis campaign.

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