High-Octane Buyback Lifts Spirits at AutoNation

Analysts, meanwhile, have been calling for this buyback since first quarter last year. Jonathan Steinmetz of Morgan Stanley issued a report about a year ago noting that the company's debt level was low enough to support a share buyback program. His analysis of this deal was positive.

Steinmetz says this transaction will give AutoNation the capital structure that falls in line with its peers. According to his calculations, after the transaction the company will have a net debt-to-capital ratio of about 30%, vs. 5% before the deal. That debt level is appropriate, he says.

Still, he cautioned that Lampert isn't afraid to use capital to push such buybacks further. He notes that AutoZone(AZO Quote), where Lampert also has a significant stake, spent $3.9 billion in share buybacks over five years. During the same period, AutoZone only generated $2.6 billion in free cash.

Leveraged share buybacks have been Wall Street's latest fancy, providing a way to rapidly alter a company's capital structure. Usually it takes some other catalyst, such as a defunct private-equity transaction or a forceful hedge fund activist, to prompt firms to execute these transactions.

Affiliated Computer(ACS Quote), for example, announced a similar deal in late January. A few months before the transaction, the company had mulled take-private offers, and later decided that the offered prices didn't value the company to management's liking. Instead, it bought its own shares by issuing debt in order to get the stock boost it was looking for. At the time, ACS said it would spend about $3 billion for the purchase of the outstanding stock.

Meanwhile, shares in ACS have shot up 9.5% since the report of the buyback, with all of that lift coming the day after the company revealed its plans.

Other repurchases have grazed headlines in recent months, and many have had a hedge fund activist somewhere on the sidelines. Phelps Dodge(PD Quote) was recently under attack by Atticus Capital to commit to share repurchases through debt issuance. Atticus, which owned 10% of Phelps Dodge, said in a letter registered with the Securities and Exchange Commission that Phelps was "significantly overcapitalized" and must "return excess capital to shareholders." At the time, the company fought back by characterizing the prospect as "reckless," saying that Atticus' proposals forced the company to place debt on its balance sheet that its operations couldn't support.

Other recent repurchases financed by debt have consistently had hedge fund activists working behind the scenes. For example, both Mylan Labs(MYL Quote) and Kerr-McGee(KMG Quote) did leveraged buybacks last summer as a result of activist campaigns from Carl Icahn.