Buyback Of Shares

Chapter 1

Introduction To The Indian Capital Market
Competitive forces with the unleashing of the liberalization policies have made corporate restructuring a sine quo non for survival and growth. Operational, financial and managerial strategies are employed to maintain competitive edge and turnaround a sickened performance. Financial restructuring involves either internal or external restructuring (i.e. Mergers and Acquisitions). In the internal restructuring an existing firm undergoes through a series of changes in terms of composition of assets and liabilities. Section 100-105 of The Company's Act 1956 governs the internal restructuring of a corporate entity in the form of capital reduction. Section 77A, 77B and 77AA now allow companies to buy back their shares following the recommendations of committee on corporate restructuring, which was set up by the government to propose various strategies to strengthen the competitiveness of the banking and finance sector, companies are now allowed to repurchase their own shares. This will enable the companies to catch up with other developed markets as part of the government's moves to liberalize the local market and hence emerged the concept of SHARE BUY BACK in the Indian corporate scenario. Over 300 companies, including the Tatas, the Birlas and Reliance, had passed resolutions -- taken shareholders permission -- at their AGMs during the year 1997-1998.

Buyback Of Shares

Sudden plethora…
Relative to the Indian context, the listing of various foreign players in the earlier times on the Indian bourses was regulatory driven. They had adequate funds in their kitty to pursue their own goals, both in terms of funding their expansion and an inherent ability to outsource and avail economic costs of production.

Why then did they still go in for an Indian listing?
In the 1970’s period, if MNC’s wanted to continue doing their business in India, they could do so only by diluting their shareholding and getting listed on the exchange. They were thus forced to go public. Now that the norms have been altered and they are permitted to carry on their business without any such compulsion, they would rather operate as wholly owned subsidiaries without being listed on the bourses.

Buyback Of Shares

Chapter 2

Buy back of shares
Share buy back is a financial tool for financial re-

engineering. It is described as a procedure that enables a company to go back to its shareholders and offers to purchase from them the shares they hold. Buy back of equity shares is a capital restructuring process. It is a

financial strategy that allows a company to buy back its equity shares and other securities. In a changing economic scenario corporate sector demands more freedom in restructuring debt-equity mix in times of favorable business environment. So far it was possible to refund shareholders' money through capital reduction process. A company could buy back own shares obtaining permission of the Company Law Board under the old provisions of the Companies Act, 1956. By virtue of the newly inserted section 77A to the Companies Act, 1956 through the Companies (Amendment) Ordinance, 1999, a new vista has been opened for flexible capital structuring by companies as and when necessary without involvement of any external regulatory mechanism. Buy back is a financial strategy - it should be used accordingly. It is not for improving controlling interest of the ruling shareholding group. However, improvement of controlling interest occurs as a natural consequence of buy back strategy. In India, companies are lowly levered because of high incidence of debt cost. But so long a company can earn above the effective debt cost it is advantageous to create favorable leverage effect.

Buyback Of Shares
Creating shareholders' value should be the primary objective of corporate management. It is difficult to service a large equity and add shareholders' value. Slimming of capital structure should be an In a situation when objective of buying back of own shares by companies. Buy back offers a straight route for swapping equity for debt. cost of capital. Prior to introduction of flexible buy back facility; once a particular equity pattern is opted for it would become sacrosanct. To alter the skewed equity a company has to build up the level of free reserves or to infuse more borrowed funds. Infusion of more borrowed fund would be possible in a growth situation. In a no-growth situation changing the equity structure was very difficult. Buy back option is expected to help to correct the positively skewed equity share capital in the existing capital structure of a lowly levered company that earns stable return. If' a company cannot deploy the surplus cash in a growth process from which it would be able to maintain average return on capital employed (ROCE) and earnings per share (EPS), what should it do with the cash? Inter corporate investments/loans although freed may not likely to improve average ROCE of the company. custodian of shareholder’s money. Board of directors is the If it cannot add better value or, equity appears to be costlier to debt, this would help to reduce overall

even maintain the current rate of value addition, it should refund the money to the shareholders. This will at the same time create better value to the leftovers. Good corporate governance demands proper utilization of shareholder’s money.

Buyback Of Shares

Restriction that has been lifted
Section 77(l) of the Companies Act, 1956 prohibited (i) a company limited by shares, and (ii) a company limited by guarantee and having share capital to buy its share. Section 77(2) of the Companies Act, 1956 disallowed a public company or a private company, which is a subsidiary of a public company to give any direct or indirect financial assistance to any person in the form ofLoan Guarantee Provision for security or In any other manner for purchase of its own shares or of its holding company. However, redemption of redeemable preference shares under section 80 of the Companies Act, 1956 were not subjected to this restriction.

Disadvantage of the capital reduction route
Capital reduction is possible for diminution of liability in respect of the unpaid amount of share capital or payment to any shareholder of any paid-up share capital. If repayment of a portion of share capital is the purpose; that can be fulfilled through capital reduction.

Buyback Of Shares
However, it is not an easy route. It requires an order of court, which in turn requires fulfillment of the following conditionsThe existing creditors should not object to the capital reduction; All claims of the creditors who object to the capital reduction should be settled; or their claims should be provided for; Contingent or unascertained claims as fixed by the court should be provided for. This route involves court process and is not flexible. exercised as a financial strategy. It cannot be

To the contrary, buy back is a

flexible approach by which a company can safeguard payment of outside liabilities before exercising buy back.

Buyback Of Shares

Chapter 3

The rationale behind buy back of shares is to boost demand by reducing the supply, which in theory should push the price up. The repurchase of shares reduces the number of shareholders, which in turn enhances the earnings per share (EPS), and thus improve investor sentiments. A company may decide to buy back its shares for one of the following reasons: To return surplus cash to shareholders as an alternative to a higher dividend payment. The management may also like to return surplus cash to the shareholders in the form of buy back when there are no proper investment opportunities to maintain the rate of return. Adjust or change the company's capital structure quickly, say for those companies seeking to increase its debt/equity ratio. Buyback facilitates reduction of share capital without recourse to lengthy capital reduction process. To increase earnings per share and net asset value per share as a possible signal to the market place that management is of the view that the prospects of the company justify a market price higher than that currently accorded by the market. To improve the liquidity of the shares and other performance parameters like EPS,DPS, operating cash flow per share,etc

Buyback Of Shares
Initially many companies may opt for equity financing to avoid high financial risk. At a later stage when the company becomes successful in stabilizing its income, it may prefer to have a levered capital structure to ensure better return on equity. Buyback can be used as a mechanism for maintaining

shareholder’s value in a situation of poor state of secondary market. Buyback announcement may temporarily arrest the downtrend. It is a mechanism to balance equity after the conversion of debt or preference share capital. To thwart the attempts of a hostile takeover. The maximum limit of shares that a company can buy back in a financial year is 25% of the total equity and the fund exposure is limited to 25% of the net worth or 100% of the free reserves, whichever is more. Pricing for buyback has been left to the discretion of the company. A company may buy back equity shares through proportionate basis (tender route) or from the open market. Buyback is reckoned as an important tool to defeat buy-back of shares since the bought back shares are cancelled and a promoter is in a position to consolidate and strengthen his position. For example, a company X, which has the following shareholding pattern is facing a hostile takeover bid : Promoter : 30 s FIs Public % : 25 % : 45 %

Buyback Of Shares
If the company proposes to buyback 25% of the total equity, then the post buyback holding of the promoters would be straight away consolidating their position to 40%. With the support of financial institutions the acquirer could be made to beat a hasty retreat.

What’s in it for the shareholders?
Dividend income received by the shareholders is liable for taxation at the normal income tax rate, depending upon the category to which the shareholder belongs. However, when buyback proceeds are received by the shareholders, they are treated as Capital Gains and are liable for Capital Gains Tax. As is common knowledge, the capital gains taxation rate is much lower then the income tax rate. The Law of Demand states that with an increase in demand, if supply does not increase, the commodity can command a higher price. The same will be true for shares too. With an increase in demand for the stock and a corresponding decline in the available free float, the value of the stock will tend to rise. After the buyback has been effected, the proportional share of the existing shareholders increases and thereby gives them a higher say and holding in the company affairs.

What’s in it for the company?
With a dearth of investment opportunities and uncertainty looming over the entire gamut of industries, most of the companies currently have a very strong cash book position. If the company uses its cash to repurchase its outstanding stock, it will enjoy a double credence:

Buyback Of Shares
The company effectively funnels in the ‘Accretion Effect’. It can decrease its floating stock in the market and at the same time increase the EPS. The growth in EPS will thus be compounded. With the growth in EPS and a stable Price Earning (PE) multiple, this will ultimately raise the Price of the stock in the market, since Stock Price = EPS * PE High cash balance reflecting in the balance sheet, will tend to drag down a few return ratios, like the Return on Assets (ROA), Return on Equity (ROE), and so on. Freeing up the cash reserves will push these ratios to a higher level, thereby reflecting a sound financial management practice.

Example 1 Let us now take a small example to understand the impact of buyback:
A company XYZ Ltd has an issued share capital of 1,000 shares of Rs 100 each. XYZ Ltd is evaluating a buyback of 100 shares of Rs 150 each, which is priced at a slight premium to the current market price of Rs 140 per share. ABC group of shareholders holds all the 1,000 shares. Under such a scenario, XYZ Ltd uses its cash reserve of Rs 15,000 to buy back 100 shares. The likely impact on XYZ Ltd would be:

Buyback Of Shares
The EPS should increase as the earnings stream remains unaffected except for the loss of interest on Rs 15,000, but the number of shares has reduced to 900. Demand for XYZ Ltd's shares should increase with now only 900 shares in circulation, against 1000 shares before the buyback. Net assets of XYZ Ltd will decrease by Rs 15,000, thus increasing the gearing, but net assets per share should remain the same. These factors should lead to an increase in the share price in one to two years.

The successful implementation of buyback depends upon two critical factors.
First, the cost of buyback, that is, the market price of XYZ Ltd's shares. For example, HLL Ltd, with its cash reserves could do a buyback but with the current market price hovering around Rs 1,700, this could be expensive. Second, the impact of buyback on the company's average cost of capital. Ideally, a buyback should drive down the average cost of capital. This may be possible only for companies with high credit rating, high cash flow interest cover and a reputed management team, which could then counter the impact of higher gearing. Contrary to common perception, buybacks may not be suitable for excessively geared companies.

Buyback Of Shares

Chapter 4

Sources of buy back
A company can buy back its own shares or other specified securities out of three sources: Free reserves Securities premium account Proceeds of an earlier issue of shares or other specified securities. [Section 77A(l)]. Buy back of any kind of shares is not allowed out of the proceeds of any earlier issue of the same kinds of shares.

Free reserve Meaning of Free Reserves
The term free reserve has been defined to carry same meaning as has been assigned in clause (b) of Explanation to section 372A. For the purpose of section 372A the term 'free reserve' has been defined as those reserves which as per the latest audited balance sheet are free for distribution as dividend and it includes balance of securities premium account. Free reserve means the balance in the share premium account, capital and debenture redemption reserves shown or published in the balance sheet of the company and created by appropriation out of the profits of the company.

Buyback Of Shares

Securities premium Account
Securities Premium Account is a broader term than Share Premium Account. Share Premium account represents only premium on issue of equity and preference shares, whereas securities premium account represents premium on issue of debentures, bonds and other financial instruments.

Proceeds of an earlier issue
Buy back of shares of any kind is not allowed out of fresh issue of shares of the same kind. If it were so, it would frustrate the very purpose of buy back. Fresh issue of equity shares for buying equity makes no financial sense. However, financial logic of buy back could very well be served if preference shares are issued and proceeds are used for buying back equity shares. Preference shares carry fixed rate of dividend. Also they are easy to market. Preference shares may give better yield to the investor than after tax yield on loan or debentures. At the same time it is possible to lever the capital structure by slimming the dividend paying equity. That apart buy back of shares is allowed utilizing proceeds of an earlier issue. Proceeds of an earlier issue is an unqualified term. Any issue means any issue of hybrid instruments, debentures, bonds, secured and unsecured loans etc. Thus buy back of equity shares is allowed byissue of any pure or hybrid debt instruments.

Buyback Of Shares
Then appropriate source of buy back should be the following if the intention is to swap equity for debt or fixed income bearing instruments: Issue of debentures; Issue of loans.

Buy Back sourcing caution
While approving the buy back resolution the following points should be carefully scrutinized as regards cash flow linkage of free reserve and securities premium account as they are not necessarily represented by free cash: How much of the free reserve and securities premium account are readily available in the form of free cash? Whether owned investments in current assets are released for buy back? If so, its impact on current ratio? Whether non-trade investments will be disposed to generate free cash? If yes, what is the possible profit/loss? If trade investments are proposed to be sold, what is the possible adverse impact on operating activities? If any fixed assets are sold, whether it has been intended to reduce the scale of operation of the company

Buyback Of Shares

Buyback Conditions:
Section 77A(2) of the Companies Act,1956 requires that buy back should be carried out ifAuthorized by its articles; A special resolution has been passed in the general meeting of the company authorizing the buy back; The buy back does not exceed twenty-five per cent of the paid u capital and free reserves of the company; also a company cannot buy back more than twenty-five per cent of its paid-up equity capital in any financial year; The ratio of the debt owed by the company is not more than twice the capital and its free reserves after such buy back; All the shares or other specified securities are fully paid up; Buy back of shares or other securities listed on any recognized stock exchange should be carried out in accordance with the Regulations made by the Securities and Exchange Board of India in this behalf; Buy back of shares or other securities other than those specified in the clause above should be carried out in accordance with the Guidelines as may be prescribed.

Buyback Of Shares

Chapter 5

Ways of Buyback
1) A company may buy-back its shares by any one of the following methods From the existing shares on a proportionate basis through the tender offer; From open market. From odd-lot holders. 2) A company shall not buy back its shares from any person through negotiated deals, whether on or off the stock exchange or through spot transactions or through any private arrangement. Buy back is not allowed through negotiated deals on or off the stock exchange. It is possible to negotiate the price and number of shares and then to complete the deal in the stock exchange. This does not give equal opportunity to other shareholders who could have also preferred to tender their shares at the same price. Negotiated deals although mean purchase of shares at negotiated price outside the stock exchange, scope of the negotiated deals has been increased to cover such transactions, which are negotiated off market and then transacted in the stock exchange. Such transactions cannot be classified as open market buyback. This will help to check privately settled buy back deals. However, it is equally difficult to trace the off market origin of a market settled transactions.

Buyback Of Shares
Buy back is not allowed through spot transactions or through any private arrangement. 3) Any person or an insider shall not deal in securities of the company on the basis of unpublished information relating to buy-back of shares of the company. Insider trading in buyback, prohibited - Regulation 4(3) prohibits any person or insider to deal in buy back transactions on the basis of unpublished price sensitive information. There is no specific prohibition for promoters to participate in buy back. Only insiders are prohibited to participate in buy back transactions except in buy back through stock exchange operation. So if a promoter is not an insider, he can participate in buy back. In case the company opts for tender offer route for buy back, all the shareholders whose names appear in the Register of Shareholders on the specified date should be offered to tender their shares.

Special Resolution:
(1) For the purposes of passing a special resolution under subsection (2) of section 77A of the Companies Act, the explanatory statement to be annexed to the notice for the general meeting pursuant to section 173 of the Companies Act shall contain disclosures as specified in schedule I. (2) A copy of the resolution passed at the general meeting under sub-section (2) of section 77A of the Companies Act, shall be filed with the Board and the stock exchanges where the shares of the company are listed, within seven days from the date of passing of the resolution.

Buyback Of Shares

Buyback Of Shares
BUY-BACK FROM THE OPEN MARKET A company intending to buy-back its shares from the open market shall do so in accordance with the provisions stated as under1) The buy-back of shares from the open market may be in any one of the following methods: Through stock exchange. Book Building process.

Through stock exchange.
A company shall buy-back its shares through the stock exchange as provided hereunder- Maximum price at which the buy-back shall be made has to be specified by a special resolution. The buy-back of the shares shall not be made from the promoters or persons in control of the company. The company shall appoint a merchant banker and make a public announcement in respect of the same. The public announcement shall be made at least seven days prior to the commencement of buy-back. A copy of the public announcement shall be filed with the Board within two days of such announcement along with the fees as specified in the provisions. The public announcement shall also contain disclosures regarding details of the brokers and stock exchanges through which the buy-back of shares would be made. The buy-back shall be made only on stock exchanges with electronic trading facility. The buy-back of shares shall be made only through the order matching mechanism except ‘all or none’ order matching system

Buyback Of Shares
The company and the merchant banker shall give the

information to the stock exchange on a daily basis regarding the shares purchased for buy-back and the same shall be published in a national daily; The identity of the company as a purchaser shall appear on the electronic screen when the order is placed. The company shall complete the verification of acceptances within fifteen days of the pay-out.

Buy-back through book building
A company may buy-back its shares through the book-building process as provided here under-: a. The maximum price at which the buy-back shall be made should be specified by a special resolution as in the case of buy-back through stock exchange. b. The company shall appoint a merchant banker and make a public announcement in reference to the same. c. The public announcement shall be made at least seven days prior to the commencement of buy-back. d. The deposit in the escrow account shall be made before the date of the public announcement. (ii) The amount to be deposited in the escrow account shall be determined with reference to the maximum price as specified in public announcement. e. A copy of the public announcement shall be filed with the Board within two days of such announcement along with the fees as specified in the regulations. f. The public announcement shall also contain the detailed methodology of the book-building process, the manner of

Buyback Of Shares
acceptance, the format of acceptance to be sent by the shareholders pursuant to the public announcement and the details of bidding centres. g. The book building process shall be made through an electronically linked transparent facility. h. The number of bidding centres shall not be less than thirty and there shall be at least one electronically linked computer terminal at all the bidding centres. i. The offer for buy back shall remain open to the shareholders for a period not less than fifteen days and not exceeding thirty days. j. The merchant banker and the company shall determine the buyback price based on the acceptances received. k. The final buy-back price, which shall be the highest price accepted should be paid to all holders whose shares have been accepted for buy-back.

Buyback Of Shares

Buyback through Tender Offer
A company can buy back its shares from the existing shareholders on proportionate basis. The explanatory statement annexed to the notice under section 173 of the Companies Act, shall contain the disclosures mentioned in regulation 5 and also the following disclosures; a. The price at which the buy-back of shares shall be made; b. If the promoter intends to offer their shares, the quantum of shares proposed to be tendered, and the details of their transactions and their holdings for the last sixmonths prior to the passing of the special resolution for buy-back including information of number of shares acquired, the price and the date of acquisition.

Filing of offer document
(1) The company which has been authorized by a special resolution shall before buy back of shares make a public announcement in at least one English National Daily, one Hindi National Daily and a Regional language daily all with wide circulation at the place where the Registered office of the company is situated and shall contain all the material information as specified in schedule II. (2) The public announcement shall specify a date, which shall be the `specified date’ for the purpose of determining the names of the shareholders to whom the letter of offer shall be sent.

Buyback Of Shares

(3) The specified date shall not be earlier than thirty days and not later than forty-two days from the date of the public announcement. (4) The Company shall within seven working days of the public announcement shall file with the Board a draft-letter of offer containing disclosures as specified in schedule III through a merchant banker who is not associated with the company. (5) The draft letter of offer referred to in sub regulation (4) shall be accompanied with fees specified in schedule IV. (6) The letter of offer shall be dispatched not earlier than twenty-one days from its submission to the Board under sub-regulation (4). Provided that if, within twenty-one days from the date of submission of the draft letter of offer, the Board specifies modifications, if any, in the draft letter of offer, (without being under any obligation to do so) the merchant banker and the company shall carry out such modifications before the letter of offer is despatched to the shareholders. (7) The company shall file along with the draft letter of offer, a declaration of solvency in the prescribed form and in a manner prescribed in sub-section (6) of section 77A of the Companies Act .

Offer procedure
(1). The offer for buy back shall remain open to the members for a period not less than fifteen days and not exceeding thirty days.

Buyback Of Shares
(2) The date of the opening of the offer shall not be earlier than seven days or later than thirty days after the specified date. (3) The letter of offer shall be sent to the shareholders so as to reach the shareholders before the opening of the offer. (4) In case the number of shares offered by the shareholders is more than the total number of shares to be bought back by the company, the acceptances per shareholder shall be equal to the acceptances tendered by the shareholders divided by the total acceptances received and multiplied by the total number of shares to be bought back. (5) The company shall complete the verifications of the offers received within fifteen days of the closure of the offer and the shares lodged shall be deemed to be accepted unless a communication of rejection is made within fifteen days from the closure of the offer.

Escrow account
(1). The company shall as and by way of security for performance of its obligations under the regulations, on or before the opening of the offer deposit in an escrow account such sum as specified in sub-regulation (2). (2). The escrow amount shall be payable in the following mannerIf the consideration payable does not exceed Rs.100 crores 25% of the consideration payable; If the consideration payable exceeds Rs. 100 crores – 25% upto Rs. 100 crores and 10% thereafter.

Buyback Of Shares

(3) The escrow account referred in sub-regulation (1) shall consist of Cash deposited with a scheduled commercial bank or; Bank guarantee in favour of the merchant banker; or Deposit of acceptable securities with appropriate margin, with the merchant banker,or A combination of all of above. (4) Where the escrow account consists of deposit with a scheduled commercial bank, the company shall, while opening the account, empower the merchant banker to instruct the bank to issue a banker’s cheque or demand draft for the amount lying to the credit of the escrow account, as provided in the regulations. (5) Where the escrow account consists of bank guarantee, such bank guarantee shall be in favour of the merchant banker and shall be valid until thirty days after the closure of the offer. (6) The company shall, in case the escrow account consists of securities, empower the merchant banker to realise the value of such escrow account by sale or otherwise and if there is any deficit on realisation of the value of the securities, the merchant banker shall be liable to make good any such deficit. (7) In case the escrow account consists of bank guarantee or approved securities, these shall not be returned by the merchant banker till completion of all obligations under the regulations. (8) Where the escrow account consists of bank guarantee or deposit of approved securities, the company shall also deposit with the bank in

Buyback Of Shares
cash a sum of at least one-percent of the total consideration payable, as and by way of security for fulfillment of the obligations under the regulations by the company. (9) On payment of consideration to all the shareholders who have accepted the offer and after completion of all formalities of buy back, the amount, guarantee and securities in the escrow, if any, shall be released to the company. (10) The Board in the interest of the shareholders may in case of nonfulfillment of obligations under the regulations by the company forfeit the escrow account either in full or in part. (11) The amount forfeited under sub-regulation (10) may be distributed pro rata amongst the shareholders who accepted the offer and balance, if any, shall be utilised for investor protection.

Payment to shareholders
(1) The company shall immediately after the date of closure of the offer open a special account with a Bankers to an Issue registered with the Board and deposit therein, such sum as would, together with the amount lying in the escrow account make-up the entire sum due and payable as consideration for buy-back in terms of these regulations and for this purpose, may transfer the funds from the escrow account. (2) The company shall within seven days of the time specified in subregulation (5) of regulation 9 make payment of consideration in cash to those shareholders whose offer has been accepted or return the share certificates to the shareholders.

Buyback Of Shares

Chapter 6

Public announcements
Public announcement is an important communication to the

shareholders detailing out the buy back. Although buy back is approved by special resolution in the general meeting, it is expected that shareholders are aware of the buy back proposal of the company through explanatory statement attached to the notice of the meeting, but there is no requirement to ensure that the resolution should be informed to the shareholders. Thus public announcement is the formal communication about the approved buy back proposal of the company. It has been discussed in Chapter Three that as per SEBI Regulations a company should not withdraw from buy back offer once public announcement is made or draft offer letter is filed with the SEBI. In case of tender offer, public announcement precedes submission of draft offer letter to the SEBI. Draft offer letter is required to be submitted within seven days from date of public announcement. The same course should be followed in case of buy back of odd lots. In case of buy back through stock exchange operation, copy of the public announcement is submitted to the SEBI and it should be made at least seven days prior to the buy back. The same process is to be followed for buy back through book building process except that a copy of the public announcement should be submitted to the SEBI within two days from the date of announcement.

Buyback Of Shares
The contents of the public announcement should cover the items mentioned in Schedule H to the SEBI Buy Back Regulations, 1998. The merchant banker appointed for buy back is responsible for ensuring that contents of the public announcement are true, fair and not misleading. Information content of the public announcement provides advance information to the shareholders about the buyback. This information is also incorporated in the draft offer letter.

Disclosures To Be Made In The Letter Of Offer
The letter of offer shall, inter-alia, contain the following: 1. Details of the offer including the total number and percentage of the total paid up capital and free reserves proposed to be bought back and price; 2. The proposed time table from opening of the offer till the extinguishment of the certificates; 3. Authority for the offer of buy-back; 4. A full and complete disclosure of all material facts including the contents of the explanatory statement annexed to the notice for the general meeting at which the special resolution approving the buy back was passed; 5. The necessity for the buy back; 6. The process to be adopted for the buy back;

Buyback Of Shares

7. The minimum and the maximum number of securities that the company proposes to buy-back, sources of funds from which the buy-back would be made and the cost of financing the buy-back; 8. Brief information about the company; 9. Audited Financial information for the last 3 years and the company and its Directors shall ensure that the particulars (audited statement and un-audited statement) contained therein shall not be more than 6 months old from the date of the offer document together with financial ratios as may be specified by the Central Government ( as per the amendment effective from March 2000 ) ; 10. Present capital structure (including the number of fully

paid and partly paid securities) and shareholding pattern; 11. The capital structure including details of outstanding

convertible instruments, if any, post buy-back; 12. The aggregate shareholding of the promoter group and of

the directors of the promoters, where the promoter is a company and of persons who are in control of the company; 13. The aggregate number of equity shares purchased or sold

by persons mentioned in clause (xii) above during a period of twelve months preceding the date of the public announcement and from the date of public announcement to the date of the letter of offer; the maximum and minimum price at which purchases and sales referred to above were made alongwith the relevant date;

Buyback Of Shares


Management discussion and analysis on the likely impact

of buy back on the company's earnings, public holdings, holdings of Non Resident Indians/Foreign Institutional Investors, etc., promoters holdings and any change in management structure; 15. 16. i. A declaration to be signed by at least two whole time directors that there are no defaults subsisting in repayment of deposit. Redemption of debentures or preference shares or repayment of a term loans to any financial institutions or banks; ii. A declaration to be signed by at least two whole time directors, one of whom shall be the managing director stating that the Board of Directors has made a full enquiry into the affairs and prospectus of the company and that they have formed the opiniona. As regards its prospects for the year The details of statutory approvals obtained;

immediately following the date of the letter of offer that, having regard to their intentions with respect to the management of the company's business during the year and to the amount and character of the financial resources which will in their view be available to the company during that year, the company will be able to meet its liabilities and will not be rendered insolvent within a period of one year from the date;

Buyback Of Shares
b. In forming their opinion for the above

purposes, the directors shall take into account the liabilities as if the company were being wound up under the provisions of the Companies Act, 1956 (including prospective and contingent liabilities)


The declaration must in addition have annexed to it a

report addressed to the directors by the company's auditors stating thata. b. They have inquired into the company's state of affairs, and The amount of permissible capital payment for the

securities in question is in their view properly determined; and c. They are not aware of anything to indicate that the opinion

expressed by the directors in the declaration as to any of the matters mentioned in the declaration is unreasonable in all the circumstances. 18. Such other disclosures as may be prescribed by the Central

Government from time to time. 19. The offer document shall be dated and signed by the Board

of Directors of the company. 20. The letter of offer shall contain pre and post buy-back debt equity ratios (As per the amendment effective from March 2000 this clause has been inserted)

Buyback Of Shares

Buyback Of Shares

Chapter 7

Extinguishment of Certificate
The company shall extinguish and physically destroy the share certificates so bought back in the presence of a Registrar or the Merchant Banker, and the Statutory Auditor within seven days from the date of acceptance of the shares. The shares offered for buy-back if already dematerialised shall be extinguished Securities under. The company shall furnish a certificate to the Board duly verified by The registrar and whenever there is no registrar through the merchant banker; Two whole-time Directors including the Managing Director and, The statutory auditor of the company, and certifying compliance as specified in sub-regulation (1), within seven days of extinguishment and destruction of the certificates. The particulars of the share certificates extinguished and destroyed under sub-regulation (1) shall be furnished to the stock exchanges where the shares of the company are listed within seven days of extinguishment and destruction of the certificates. and destroyed in the of manner India specified under and and Exchange Board (Depositories

Participants) Regulations,1996 and the bye-laws framed there

Buyback Of Shares

The company shall maintain a record of share certificates which have been cancelled and destroyed as prescribed in sub-section (9) of section 77A of the Companies Act,.

Buyback Of Shares

Chapter 8

Skewed Equity Structure
An important buy back objective is to swap equity for debt. Initially a company may opt for high equity structure to avoid financial risk when its capacity utilization is not very high. The next phase is stabilization phase when it should try to rationalize its equity structure through proper debt-equity mix. The debt-equity ratio pattern of many Indian companies is lop-sided. This situation prevails because of a wrong appreciation about the cost of equity. If dividend is considered as cost of servicing shareholders' funds, in many cases equity seems to be cheaper source of finance. In fact this approach turns the shareholders away from the company. In India, the debt equity ratio is greater than one for few companies and is greater than two for even fewer companies. This is mostly guided by the f act that cost of equity servicing is cheaper to cost of debt.

Why to go for Leveraged Buy back
Many strategists like more debt in the capital structure. There are many reasons for preferring levered capital structure—

Buyback Of Shares
Debt has tax saving effect whereas in equity servicing distribution tax has to be paid on dividend payment. If the target is to achieve shareholders' value added (SVA) replacing equity at its market price by debt does not matter. It is inappropriate to consider that more money is pumped in to replace equity. Equity should be looked into always at its market value. That will facilitate equity servicing. When a company's equity is not even cheaper taking dividend cost, it is better to replace it using debt. Debt will bring tax benefit, reduce overall cost of capital and increase economic value added (EVA) – Debt cures reinvestment risk. The management of an equity finance company is often faced with the reinvestment challenges. They desperately search for reinvestment alternatives. The management of many of the may face a problem of surplus cash. Equity grew over the years. Where to park the money? Often the money is locked in many unremunerative projects. For ensuring increase in the share price to give commensurate return to the shareholders, free cash flow should be reinvested judiciously. One important advantage of having debt is its servicing pressure. The level of free cash flow is reduced - repayment of debt becomes a constraint. The management can source fund for growth which it has to service at competitive market rate. This keeps the management alert in the market front. Debt creates motivational effect to earn competitive rate of return. Managing a company with the so-called cheap equity fund may not create adequate motivational effect to earn better. Compulsion of debt servicing creates an urge to improve performance and earn better.

Buyback Of Shares
Debt compels spin off. The pressure of debt servicing

compels the management to rethink about the under performing assets. The division which cannot generate adequate cash flow for debt servicing may not be liked. Whereas if it was financed by free reserve it might not be so alarming. Debt stops the management from cross-subsidizing the under performing units. In the liberalized environment of inter-corporate loans and investments, the persons in control of the company may attempt to cross-subsidize the inefficient units, which may eventually prove costly even for the parent company.

Driving equity out by debt
The traditional attitude of borrowing to finance only new projects or modemisation or working capital has its limitation. The company should borrow to its full capacity of borrowing. If the target debt ratio is set befitting with the debt servicing capacity of the company, it is possible to reduce cost of capital using cheaper debt. Cash flow generated through, debt if used for retiring equity, future free cash flow can be used to retire debt at a cheaper rate. This will improve value of equity of the non-tendering shareholders.

Conditions for Leveraged Buy Back
Since equity is costlier to debt, the management may think for buy back equity through issue of debt instrument. precondition of leveraged buy back? Debt servicing coverage of the company should be good; What should be the

Buyback Of Shares
Free cash flow to debt coverage is good; Business risk is moderate. Debt service coverage ratio is given byCash flow available for debt servicing Debt Installment + Interest Cash flow available for debt servicing is determined by operating cash flow net of tax payment plus income from investment and other income included in the Cash Flow from Investment Activities. flow from operating activities is determined before depreciation and other non-cash expenses and losses. Cash charging

A successful leveraged buy back is dependent on many factorsPre-buy back market price -If market price of equity
share is high, premium component will be high and dividend-paying equity cannot be driven out cheaply. A higher premium could reduce EPS.

Interest rate cut may bring opportunity for cheaper debt
financing. premium Even if old debt cannot be repaid because of high claimed by Financial Institutions on premature

redemption, infusion of new debt would reduce the cost of capital. Then a company may need to adopt leveraged buy back for reduction of cost capital for capital restructuring.

Business risk is stable; acceptance of higher debt ratio
should not increase the total risk to a great extent.

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ESOP - If it becomes necessary to buy shares held by ESOP to
provide it liquidity while discharging liability to a retiring employee in cash rather than by way of proportionate shares, often the management finds finance through borrowing.

Dividend pay out ratio When a company has reached a
very high level of dividend pay out ratio, which becomes unsustainable, it can cut the dividend rate to reduce the market price and then it may adopt leveraged buy back. A dividend cut will bring down equity cost and in the process of leveraged buy back it can find a favourable drive out premium. This will improve value of the non-tendering shareholders.

Saving in dividend also reduces the cash flow matching
problem for debt servicing effectively.

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Chapter 9

Relevance of pricing
Buy back pricing has many facets depending on the method deployed for buy back. In tender offer, a company announces fixed price at which shares to be tendered. There is no choice left to the tendering shareholders. Of course, to be successful the buy back offer price should be better than the comparative market price. What constitutes comparable better price? What maximum price

should a company offer for buy back? In open market operation through stock exchange operations, a company has to pay market price. But the impact cost in stock exchange operation may push up the company's cost ending up with lower buy back quantity. So stock exchange operation may not necessarily produce finest result. In book building process the company offers a price cap and the current stock market price offers the automatic floor. Tendering shareholders have to choose a price within that range. The company's job is to appreciate the market price impact of buy back and value impact before putting price cap.

Valuation approaches
Valuation of share is an important aspect of buy back pricing. A

company should have complete knowledge about the intrinsic value or fair value of share. Intrinsic value of share is the weighted average of-

Buyback Of Shares

Asset backing value; Profit Earning, Capacity Value Market value. Weights are chosen in accordance with financial position and profitability of the company. Although buy back essentially and implicitly emphasizes on going concerned basis, so relevance of asset backing value may be questioned. But there are circumstances when shares of many blue chip companies are traded at less than their book values. One important objective of back is to pay proper price to the shareholders in the distressed market. It is not for buying back the shares cheaply. Rather it offers premium exit route in the distressed market, which makes stock market attractive. A company that cares for its shareholders always comes out to protect the market price. This is one of the purposes of allowing buy back in India. So one cannot ignore the asset backing value while pricing buy back.

Asset Backing Value
Asset backing value is given by net assets value available to the shareholders divided by number of shares outstanding: Net assets available to the equity shareholders Number of outstanding equity shares

Buyback Of Shares
Steps to be followed in determining net assets available to the equity shareholders areDetermination of the, value of the various assets - Tangible fixed assets, Capital Work in progress, Investments, Current assets, Loans and Advances, Miscellaneous expenditure and losses which are fictitious assets should not be counted. Valuation of goodwill - It includes valuation of all intangibles like brand, patent right, franchise, know-how, etc. generate additional operating profit. Whatever the company has spent on intangibles that has value only if it can

For deriving Asset backing value the following steps are followed: Current costs of assets are determined; Value of goodwill is added to total current cost of tangible assets; AU liabilities and provisions are deducted; Preference share capital is deducted; Adequate provision is made against contingent liabilities and deducted from current cost of assets; Net current cost of assets are worked out which represent current cost of equity; Net current cost of assets is divided by number of outstanding equity shares. The business is a going concern in the context of buy back. The following valuation norm may be followed for valuation of assets: Fixed assets are valued at lower of the current entry price and current exit price.

Buyback Of Shares
Capital Work-in-progress are yet mature as revenue generating assets, so they should be valued at cost. Quoted investments are valued at market price. Unquoted investments are valued at their asset backing value in case asset-backing value is not available, book value can be used for this purpose. Current assets are valued at lower of the net realizable value and cost. For comparing cost and market price of inventories item by item comparison should be carried as required in Accounting Standard-2. Similarly, for other items of current assets like debtors, loans and advances item by item comparison should be made. This will make automatic provisioning of current assets. Miscellaneous expenditure and losses should be excluded. All liabilities should be taken at the redemption value.

Price Earning Capacity Value
PECV is given by the discounted value of profit available to the equity shareholders. A 1 0 - year time frame may be considered for the future maintainable profit. Weighted Average Cost of Capital (WACC) of the company is used as discounting factor. Underlying principle of the PECV is that Future Maintainable Profit can be earned in the next 10 years. Thereafter the realisable value of the net asset is taken as cash flow. Steps to be followed are as follows: Find out average maintainable profit. Depreciation is deducted because it is an item of economic expense. I

Buyback Of Shares
Find out weighted average cost of capital (WACC) Deduct preference dividend including distribution of tax from future maintainable profit to arrive at profit available to equity shareholders; Assume that profit for a period of ten years and discount it using WACC; Find out realizable value fixed assets - this is given by depreciated value of fixed assets; Take the realizable value of investments and current assets at par.

Buyback Of Shares

Chapter 10

Tax Implications of Buy Back:
Buybacks are now imminent, but there seems to be lot of confusion as to the tax implications and the buyback code and regulations. The ministry of finance has not yet clarified the position, but the likely tax consequences could be derived from first principles. Lets take an example to understand this better. A company XYZ Ltd has an issued share capital of 1,000 shares of Rs 100 each. XYZ Ltd is evaluating a buyback of 100 shares of Rs 150 each, which is priced at a slight premium to the current market price of Rs 140 per share. ABC group of shareholders holds all the 1,000 shares. We assume that XYZ Ltd's company rate of income tax is 35 per cent and the capital-gains tax rate is 20 per cent. As to the impact on XYZ Ltd, there are three alternatives - to treat it as a revenue expense or capital expense or as a distribution. If XYZ Ltd is able to deduct Rs 15,000 as revenue expense, it saves tax @ 35 per cent of Rs 5,250, thus reducing the effective cost of buyback to Rs 9,250. This would make a buyback significantly cheaper with an equivalent loss of revenue to the exchequer. But this expense though wholly and exclusively for business would not qualify as "necessarily" for business.

Buyback Of Shares
Secondly, in substance, it remains an equity transaction with owners of the company, for example, the ABC group, and not an expense for conducting the business of XYZ Ltd. Alternatively, XYZ Ltd could treat it as capital loss of Rs 50 per share purchase price of Rs 150 less Rs 100 face value. XYZ Ltd could then offset such losses against other gains. This is far-fetched as XYZ Ltd has not sold any asset whether fixed or current nor extinguished any liability. Again, it looks like an equity transaction with the owners, which is distinct from buying or selling an asset. The third option is to treat it as a special dividend. This amount of Rs 15,000 represents excess accumulated return on capital over the past year, which has now been paid out in one installment. XYZ Ltd will then have to pay tax of 10 per cent on Rs 15,000 as it would for any interim or final dividend. Therefore, XYZ Ltd bears the tax burden for distributing its net assets of Rs 15,000 to its owners ABC. This is the treatment adopted worldwide. Thus the special dividend treatment reflects the substance of a buyback, which is distribution of excess profits. The buyback code could then require a transfer of Rs 15,000 from distributable reserves of XYZ Ltd to undistributable reserves to protect the creditor's buffer and ensure consistency with dividend treatment. As to the impact on XYZ Ltd's shareholders, there are two alternatives. ABC can treat Rs 15,000as capital receipt or dividend receipt. Under section 2 (47) (ii) of the Income Tax Act, shares are deemed to have been sold if there has been a change in shareholders' right to vote or right to receive dividend or right to receive excess capital on liquidation.

Buyback Of Shares

In our example, though ABC now owns only 900 shares, ABC can still exercise the same proportion of votes, that is, 100 per cent and has the right to receive 100 per cent of XYZ Ltd's dividend. Therefore, Rs 15,000 in such circumstances is likely to be treated as dividend receipt. As dividends are tax-free, the net receipt to ABC is Rs 15,000, which is only fair if XYZ Ltd has already borne the tax burden. This will be so when XYZ Ltd treats Rs 15,000 as dividend payment and not as revenue or capital expense. Thus shareholders should also treat most of the buybacks as dividend receipts, assuming that the company makes a proportionate offer of buyback to all shareholders in the same class. This would be a legal necessity under the buyback of preference shares. Say XYZ Ltd wants to buy back all its 100 15 per cent voting preference shares at Rs 150 each (face value of Rs 100). Here the preference shareholders have lost the right to cast those 100 votes and the right to receive Rs 15 of annual dividend. Therefore, they will be deemed to have sold the shares and the net gain of Rs 5,000 will become taxable (Rs 15,000 proceeds less Rs 10,000 cost). This net gain will be taxable at the rate of 20 per cent, reducing the net receipt to Rs 14,000. This capital receipt treatment will be relevant only in such exceptional circumstances of a buyback. Thus the accounting principles dictate that companies and

shareholders treat buybacks as a special dividend payment. If buybacks are treated as a revenue or capital expense, then this would result in significant inconsistency between Indian business standards and tax practices and those of rest of the world. More importantly, the

Buyback Of Shares
revenue or capital treatment would lead to government tax subsidies on buyback payments made by profitable companies to their enriched shareholders. Even capitalist countries like the US and UK do not subsidize such distributions and, therefore, to subsidize such transactions in a country like India would lead to a unfair and unjust taxation system. Minority shareholders also need to be protected and, therefore, the buyback code should incorporate two safeguards: The buyback offer should be made to all shareholders and it cannot be priced below the market price.

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Chapter 11






resorting to buy back
The following are the general obligations of company, which has resorted to buy back: Letter of offer, public information and other publicity material should contain true and factual information. There should not be any misleading information. Company should not issue any shares including bonus shares till the closure of the offer. It may be mentioned that a company will not be entitled to issue shares on closure of the offer excepting issue of bonus shares, in discharge of subsisting conversion liability, sweat equity and issue of shares to ESOP. The prohibition period should be earlier of the specified date or public announcement. This is because although special resolution is passed, a company may eventually put off the buy back decision. Buy back consideration should be discharged only by way of cash. No withdrawal from the buy back is allowed after the draft letter of offer is filed with the SEBI or public announcement is made. This is to prevent creating market confusion through futile buy back offer.

Buyback Of Shares
The promoters or persons in control of the company should not deal in shares of the company in the stock exchange during the buy back offer period. operation. However, they are allowed to participate in tender offer or buy back through book building. This is targeted to prevent the possibility of insider trading. However, this may not be able to prevent any attempt to pull down the price by creating selling pressure during the book building process. Public announcement for buy back cannot be made during the pendency of any scheme of amalgamation or compromise or arrangement. No purpose can be served by this restriction, in normal Course; a company has been prevented during the period of offer and during cooling period to issue shares. So if buyback starts the company will not be in a position to discharge equity swapped amalgamation. As a means of investors' protection Regulation 19(3) requires nomination of a Compliance officer by the company who will ensure compliance with the legal aspects of the buy back. This could be the responsibility of the merchant banker. Buy back of shares which are in the lock-in period is not allowed till the pendency of lock-in period and until the shares become transferable. The promoters and persons having controlling interest cannot participate in the buy back through stock exchange

Publication of buy back information

Buyback Of Shares
The company is required to make public announcement by way of advertisement in a national daily within two days from the date of completion of the buyback inter alia disclosing: Number of shares bought back; Price at which shares are bought back; Total amount invested in the buy back; Details of the shareholders from whom more than 1% of the shares are bought back; Consequential changes in the capital structure and shareholding pattern before and after buy back.

Buyback Of Shares

Chapter 12

Buyback in India
In India the Buyback clause comes with certain clauses.
The main objective of these clauses is to prevent Promoters from malpractice. For example with Buyback a co. might be able to improve its EPS & improve the Market value of the scrip (assuming at constant P/E) & thereafter come up with an IPO at a higher premium to shore up the Share Premium Account. Or that a promoter might be able to corner a substantial number of shares through open market purchases (not triggering the Takeover code, however) & force the company to buy back these shares at a higher price, making a clean profit in the process. To prevent such malpractice the Working Group has recommended the following: Any company that buy back its shares will not be allowed to issue fresh capital, except bonus issue, for another 12 months if the shares are bought back & extinguished, and for another 24 months if the shares are held as Treasury Stocks. This will prevent manipulations of share prices through Buyback. Promoters have to specify the amount to be used for Buyback & get prior approval of shareholders. Only Free Reserves are allowed to be utilized for the purpose of Buyback.

Buyback Of Shares

It has been argued hotly that a company will be rewarding the shareholders through a Buyback route as well as it does through Bonus & Rights issue, Dividends, etc. If a company buys back the shares and extinguishes them, its Equity decreases to that extent, thereby increasing its EPS. And it is been assumed that the market price of the share increases to match the pre-Buyback price to the Earnings ratio. Buyback also helps a co. to maintain a target capital structure. When the RONW of a co. is less than ROCE, it implies that the capital structure is lopsided with excess Equity. The co. can buy back the Equity & replace it with Debt to improve its RONW. The key question that inevitably follows is that which is more beneficial to the investors, a Dividend or a Buyback? This is a subjective question that depends on the market price of the scrip & the price of repurchase.

Buyback in India
Only multinational companies, which are keen to hike their stakes in Indian ventures and promoters with low equity holding will seriously think about buyback (as promoters are not allowed to participate in buyback, their stake will increase once the company buys back shares from other In India though many specified group cos. qualify for Buyback, at current prices, not many of them will be able to utilize their cash flow to buy back their shares, as it will directly affect their cash requirements for normal operations. Cash rich cos. like Reliance

Buyback Of Shares
Industries, Bajaj Auto, TISCO, TELCO, HLL, etc. will have to shell out huge amounts to buy back even a fraction of their Equity at prevailing prices, which are obviously higher than the BV of the shares. The other problem is that most of the Indian cos. have a Debt-Equity ratio greater than one. Buyback would definitely increase this ratio & reduce the leveraging capacity of the Co. This is specially applicable to cos. having a high proportion of fixed assets, like TISCO & TELCO. Coupled with the fact that the co. will not be able to issue new shares for at least one year, this implies that the co. will not be able to go in for any expansion for the next one year or so, this would be definitely a big dampener to the whole concept of Buyback. It has been argued that in India Buyback will be used predominantly to ward-away hostile takeover bids. However the utility of Buyback as a tool of defense In India is questionable under the existing regulations. For example in the US, cos. are allowed to borrow to buy back their shares in case of a takeover bid. However in India a co. is not allowed to undertake fresh borrowings for the purpose of Buyback. This means that weaker cos. which are inevitably takeover targets cannot resort to Buyback as a defense mechanism. The lacunae in the buyback guidelines need to be addressed like the applicability of SEBI’s takeover code. A company buying back to a certain percentage, will it necessarily have to comply with the SEBI Takeover Code regulations. For, on dilution, the proportion of shares held by the promoters would increase and set off a trigger under Regulation 10 of the SEBI Takeover Code.

Buyback Of Shares
Further, the takeover code gets triggered when shares beyond a specified threshold limit are acquired. This entitles the acquirer to exercise a certain percentage of voting power. In case of buybacks, there is no increased entitlement to voting rights. For, under Section 77 A (7) of the Companies Act, 1956, a company buying back its shares is not entitled to hold the same but has to statutorily cancel them. Hence, a share buyback may not entail triggering of the takeover code. Also as per the provisions of the Indian Stamp Act 1899, share transfers attract stamp duty and require the company to register the shares bought back in its name. In case of buybacks, these shares have to be statutorily extinguished. Hence, they do not get registered in the acquirer’s name. The names of the shareholders have to be struck off from the register of members too. Hence stamp duty would not become payable in a share buyback. Further, in the case of foreign JV, where the government has permitted a fixed ratio of investment, the Indian company has to maintain the same percentage in case of a buyback. Recently, there have been reports that the government is proposing to exempt multinational joint ventures from extinguishing shares bought back, provided the foreign equity holding in the company is equal to sectoral caps post-buyback. This has not been brought into effect as yet. Given these pitfalls, Buyback as a concept & as a tool cannot make much headway into the Indian corporate financial handbook. There have to be modifications in the existing legal framework to make this concept work in India.

Buyback Of Shares

Buyback Of Shares

Chapter 13

Recommendations & Findings
What should you look at before participating in buybacks?
Ever since the buyback of shares was allowed in India, there has been a lot of confusion among shareholders; as whether to sell-off their stake in the company or to retain it. To opt for a particular option is not as easy as it appears. The perception of the shareholders about the future of the company is the most important factor that influences their decision. However, that decision may not be accurate since they might not have complete access to the internal and external strategies of the company. A lot of careful thought has to be given before a final decision is taken. Here’s a way on how to go about it.

Debt-equity ratio is an important criterion. The companies
having high debt burden are unlikely to have free cash. They should prefer redeeming their debt first, to buying back equity. MNCs having subsidiaries in India are unlikely to have any motive of rigging up the share price and their buyback offer is likely to be genuine.

Track record of raising capital in the past. Companies that
have frequented the capital markets to raise money are unlikely to be good candidates for buyback.

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Look at ROCE/RONW-The companies with consistently high
ROCE/RONW are more likely to have free cash than others.

Checkout the previous price pattern of the share
Companies generally tend to buyback shares at a higher premium over the market price if they feel that their shares are under-priced. This decision to buyback often leads to an increase in share price. At this stage, you have to analyse the fluctuation in the price of the scrip for a specific time period (say one year) and if you find that the scrip moved a band lower than the offer price, selling of the scrip would be a better option.

Take note of Irrationality A buyback offer with a huge
premium may appear very attractive. Investigate and ensure that any temporary negatives do not affect the share price. If you feel that the share prices of the company are presently undervalued, refrain from selling, since a company buying back its shares is indirectly conveying that its shares are undervalued.

Take a long-term perspective It would be difficult to
envisage whether a company would issue bonus or split shares or make an acquisition. But these factors can be sidelined if the fundamentals of the company are strong and you expect the company to perform well in the future. Therefore, in the long-term perspective, the scripts of such companies should not be sold.

Dispose off volatile shares Despite strong fundamentals,
the shares of a few companies are highly volatile and exhibit wild oscillation in prices. If you want to play it safe and avoid volatility, selling out would be a better option.

Buyback Of Shares

Selling off for profit The first question that comes to mind
once you decide to sell your scrip is whether to opt for a buyback or to sell it in the market. Even after buyback is announced, the purchase price need not necessarily be the highest if a price band is given. Further, there is no guarantee that all the shares offered for buyback would be bought. Companies mostly buy about 10% of the equity in buybacks. In such cases it would be wiser to sell your stake in the market at a time when prices of your scrip are trading at a price equivalent to the highest in the offer band. Finally, one should keep one thing in mind, that buyback has no impact on the fundamentals of the company or on the economy. The only thing is that one should be cautious of unscrupulous promoters' traps and do not fall prey to them. The provision to allow buyback can be a booty for long-term investors who want to stick on in good companies, but it can be a terrible bait in many others.

Caution is advised in the following types of companies:
Where the management talks about buyback, as market has not valued their shares fully. To my mind, a good management will never bother about its share price and valuation as done by the market. It would know that if it continues to perform well, the market has to take notice in the long term.

Buyback Of Shares
Where the management has passed, with a lot of publicity, special resolutions empowering the Board to buy back whenever allowed. Anybody with the genuine intention of buying back to enhance shareholders' wealth would try to do so with minimum publicity so that the share price does not flare up. Buyback has no impact on the fundamentals of the economy or companies. Investors should be cautious of unscrupulous promoters' traps.

To sell or not to sell?
When confronted with a buyback offer, one shouldn’t just be guided by the offer price in relation to the prevailing market price. Yes, if you were looking to exit the stock anyway, that’s perhaps all you need to look at. However, if you are a medium- to long-term investor in the company, you also need to weigh the implications of the buyback on the company and its stock–and, therefore, your investment.

Earnings per share (EPS).
Post-buyback, the EPS of a company is bound to increase due to a reduction in equity. However, going forward, the EPS could fall if the performance of the company deteriorates, or if the funds used for the buyback earned significant additional income for the company. Hence, future prospects of the company ought to be your biggest consideration while evaluating its buyback offer. If the company is expected to record healthy growth, it pays to stay invested in it. However, if it is expected to founder, exiting might be a better option. This fact is borne out by the contrasting post-buyback

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numbers of two companies that have bought back stock in recent times, Bajaj Auto and GE Shipping . Adjusted for the buyback, Bajaj Auto’s EPS increased from Rs 51.4 to Rs 60.7. However, soon after, for the financial year ended March 2001, its EPS fell to Rs 25.9 due to a decline in two-wheeler sales from 1.43 million units to 1.2 million units.

Book value.
This is the per-share value of the company’s assets as valued in its books. Other things remaining constant, you stand to gain by exiting if the buyback price paid by the company is above its book value. However, if the price paid by the company to buy back its stock is less than its book value, you gain by staying on. Bajaj Auto made its tender offer at Rs 400 per share, a premium of almost 50 per cent to its pre-buyback book value of Rs 268 per share. As a result, post-buyback, the company’s book value dropped 3 per cent to Rs 260 per share. Since the premium came from its existing reserves, residual shareholders actually ended up sharing the cost of the premium paid.

Return on equity (RoE).
Post-buyback, the net worth the company must service decreases. Even if the company does not expand its bottom line considerably, this would result in an improved RoE for residual shareholders. But an increase in RoE that results from a reduction in the net worth, as opposed to an increase in earnings, may just end up being a one-time improvement. Hence, look at the company’s track record

Buyback Of Shares
on RoE and also assess its future earnings potential before choosing to stay on as a residual shareholder in it.

Promoter’s stake. A buyback increases the promoter’s
stake in his company. When a buyback is announced, look at the stake of the promoter and his associates in the company, before and after the buyback (assuming the offer is fully subscribed). Cash-rich companies where the promoters have a low holding and are keen to increase their stake could well make further buyback offers at a later date–often, at a higher price. There are many old economy companies that fit this profile. A good example is GE Shipping. In January this year, the company announced a Rs 150 crore buyback from the market at a maximum price of Rs 42 per share. It completed the buyback at an average price of Rs 35 per share, and the Sheths hiked their stake from 17 per cent to 21 per cent. GE Shipping is currently in the midst of its second buyback exercise. It has earmarked Rs 100 crore to buy back equity at a maximum price of Rs 42 per share. At that price, the Sheths’ holding in the company will rise to 25.8 per cent. However, given the weak stock market and the recent downturn in the shipping industry, the stock is languishing near Rs 23, and the company might well complete the buyback paying less than Rs 100 crore. In better times, though, the same buyback could have been closer to the offer price. However, when a company makes a buyback with the prime intention to increase its promoters’ stake, it’s dipping into its net worth without

Buyback Of Shares
necessarily meaning to increase shareholder wealth. Therefore, you need to evaluate the impact the outflow of funds would have on the company’s operations and whether this could be detrimental to future growth.

Price and liquidity.
A buyback rouses interest in a scrip. When done through open market purchases, it creates a cap or floor for the stock. In a bullish market, the buyback price creates a floor for the scrip in the secondary market. When Reliance offered to buy back its shares in June 2000 at Rs 303 per share, this effectively became the floor price for the stock. The stock traded below that level for just 11 days over the next 264 trading days, as market players anticipated that Reliance would step in and make purchases if it dipped below Rs 303. In a bearish market, though, this is reversed–the maximum buyback price becomes a ceiling price for the scrip. Reliance never did pick any stock till June 2001 (when the initial buyback approval lapsed). It took fresh approval, on the same terms. Post-September 11, the scrip hasn’t breached Rs 303. In this bearish market, investors are not inclined to pay more than what the management perceives to be a fair value for the stock. A buyback has greater implications for investors in illiquid stocks, as it offers them a much-needed exit route. However, post-buyback, liquidity in such stocks is likely to decline further due to a drop in their free float. It’s not a good idea to hold an illiquid stock–low liquidity results in poor price determination. In extreme cases, where a

Buyback Of Shares
promoter’s holding crosses 90 per cent, the company has to delist. So, always keep in mind the promoter’s stake and the stock’s free float in the market.

Buyback Of Shares

The bottomline.
Buybacks should be used as an opportunity to exit only when there is concern over a company’s prospects or when the post-buyback free float is expected to shrink considerably. In most other cases, buybacks do offer the lure of an immediate benefit–but you might be better off as a residual shareholder, and gain from a hike in the share of assets and profits of the business.

Buyback Of Shares

Chapter 14

Share buybacks, if handled badly or in an imprudent manner can exacerbate a sinister situation. The recent spates of buybacks at a torrid pace are leading to a flight of capital from the stock markets. Buybacks coupled with mergers and acquisitions are gnawing at the free float available to the investors. The utilization of a company’s cash reserve to fund it’s re purchase plans, if viewed in entirety also leads to reduced ploughing back of funds for fuelling operations and a higher debt perspective on the balance sheet. Many companies have in fact initiated borrowing to finance their buyback programs. This might bestow upon the company various tax advantages but at the same time it amounts to replacing equity with debt. Dividend yield may eventually lose importance as more and more companies substitute their dividend plans with buyback plans. The company stock. gets highly leveraged and changes the shareholders perception of the company from being an income stock to a growth

While scrutinizing a buyback offer, attention must be paid to the size of the buyback relative to the company’s free float and with the newly granted stock options. The buyback announcements are a mere statement of the company’s intentions and need not necessarily be

Buyback Of Shares
effected in actuality. However, if the announcement is backed by a tender offer, the possibility of the fulfillment of buyback promise does exist.

Will Buybacks Backfire??
Finance theory suggests three main motives for a firm to use a share buyback: Tax motives A signaling motive or A takeover deterrent motive.

It is through these lenses that the framing of buyback norms should be viewed. There has been some theoretical research on the use of share repurchases as a signaling device. Some of the conclusions worth restating are: The offer premium, the target percentage of shares sought and the percentage of insider holdings have been perceived as signal devices – the higher each of these parameters, the more positive is the signal When there is a small disparity between intrinsic worth of a firm and its market price, dividends are the preferred distribution mechanism. If the price disparity is large, a smaller cash outlay on share buyback can convey the same information as a relatively larger dividend

Information asymmetry between managers, investors with larger holdings and small investors means that the smallest distributions should be paid with dividends, larger distributions should take the

Buyback Of Shares
form of open market repurchases and tender offers should be used for the largest distributions. The yardstick for deciding the size of a signaling buyback is its materiality level, a number that measures how much impact the buyback will have on the wealth of shareholders who keep their shares. The materiality level for any given number of shares the company may buyback depends on the degree to which the market undervalues the company. But all too many companies routinely underestimate how many shares they need to buy to send a credible signal to the markets. While buybacks are typically sized in the 5-10 percent range, they typically need to be closer to 20 percent to have a material signal. Buybacks are a more tax efficient form of cash distribution to the firm than dividends (the firm saves on dividend tax). Furthermore, they create value through changes in capital structure (the tax shield of debt increases firm value). However, there are some concerns that need to be addressed in the currently uncertain economic climate in India. Taxable income in India can be highly cyclical if the economy continues to nosedive. Given the current short cooling off period (period in which no fresh issue of shares is permitted after the buyback) of 6 months, will the change in capital structure be perceived by the market to be permanent? In the absence of clear answers, a case for increased valuation due to changes in capital structure on account of buybacks remain tenuous. It is suggested that managers repurchase shares to prevent takeovers, but only if the cost of doing so is not too high. The recent success of

Buyback Of Shares
attempts at "greenmail" in India and UTI’s disastrous finances and attempts to increase value of under performers in its portfolio through change in management is causing many mid-cap companies to consider buybacks. It is also causing many multinational subsidiaries to indirectly increase their parent companies stakes using corporate cash with an eventual objective to delist. This is probably not in the interest of financial institutions like UTI. Delisting by multinationals is not in the interest of India’s capital markets. Thus one can say that buybacks increasingly look less of a boon. Some of the leading merchant bankers have prepared lists of potential companies with good reserves, but inquiries reveal that only less than a dozen of out of 300 companies will really pursue the buyback move in right earnest.

Buyback Of Shares

Chapter 15

Buy Back of PSU's Shares
The Central Government is reportedly planning to adopt buy back route for mopping up Rs. 10,000 crore. Reportedly buy back route may be adopted by big PSUs including Indian Oil Corporation, Bharat Heavy Electricals Ltd., Oil and Natural Gas Corporation, Bharat Petroleum Corporation Ltd., Gas Authority of India Ltd. and NALCO. In view of the prolonged bearish spell in the capital market the Central Government has failed to achieve targeted disinvestments in the PSU shares. Buy back route seems to be better than disinvestments because in this the Central Government can fix the price as per prudential valuation. Reportedly the core group of secretaries has The PSUs have huge accumulated identified four cash rich oil PSUs, namely, IOC, BPCL, ONGC and GAIL, for the first trench of buy back. reserves to satisfy the upper ceiling of buy back. A few other cash rich PSUS, namely, BHEL and NALCO, might be considered as a buy back candidate in the second trench. Under the buy back route the PSUs may launch buy back applying book building process. In case the quote of the Central Government is lowest it may be able to sell the desired shares, which it targeted in the disinvestments route. However, in the buy back route the PSUs have to buy back shares of ordinary shareholders also on the basis of competitive quote. In case tender offer route is opted for fixing up a fixed price, the likelihood of other shareholders participating in the buy back cannot be eliminated.

Buyback Of Shares

Reportedly, the buy back may be financed by the financial institutions. This means IOC, ONGC, BHEL, etc. should swap equity for debt. Reportedly, the basic telecom service provides MTNL plans to buy back its share. Present Government holding in MTNL 57.16% is expected to come down to 54.94 % because of the proposed issue of equity shares to the employees to the extent of 2.22%. So to maintain Government holding at 51%, the MTNL can buy back about 16.75% of its present equity share capital.

Buyback Of Shares
Annexure: What you can’t buy back... Buybacks and open offers bring a much needed infusion into a market gasping for liquidity. But what are their real effects on the market? Buybacks and open offers gather steam in corporate India in 2001 Max Offer Offer offe Targete Targete size Offer size r d d Buybacks Rs Open offers price Rs pric stake stake crore Rs crore e % % s s Rs Reliance 303 1100 4 Castrol 350 865 20 Tata 60 163 15 Hitech Drilling 92 147 77 Chemicals GE Shipping 42 100 N.A. Carrier Aircon 100 110 49 Siemens 250 81 25 Otis Elevator 280 109 31 Bombay German 60 62 25 650 107 20 Dyeing Remedies Finolex Ind 40 60 N.A. Thomas Cook 352 104 20 Britannia 750 55 4 ITW Signode 80 90 49 Ind Jayshree 75 8 10 Rhone Poulenc 875 79 20 Tea In the current dismal market conditions, the only stocks that are showing any signs of resilience are those that have open offers or buybacks in progress. At a time when FII inflows seem to be slowing down, these offers are the lone hope of fresh liquidity coming into the equity markets. Of late, quite a few companies have taken to the buyback route as a means to pay out excess cash to shareholders. Promoters with low stakes are also turning to buybacks to hike their holdings, using the company’s money rather than their own funds. As restrictions on foreign ownership become less stringent, many multinational companies have hiked stakes in their Indian subsidiaries

Buyback Of Shares
via open offers. These usually follow disappointing financial results, making one wonder whether it’s coincidence or a strategy to buy the stock cheaper. With greater global M&A activity, mandatory open offers by new parent companies have also gained in pace. Our table lists the major buybacks and open offers to hit the market in 2001. Our estimates show that the total amount earmarked for these offers is a substantial Rs3600 crores. That’s in addition to the Rs4000 crores that came in during 2000. It should be noted that a number of open offers have been made at low prices, leading to poor response from shareholders. In the case of buybacks, the Rs1100 crores ear-marked by Reliance Industries may actually never materialise due to the fact that market price is till date above the maximum buyback price. Thus, while the payout to investors may be well short of the estimated Rs3600 crores, it’s still a figure to reckon with. Whatever the amount, it’s hard to see investors ploughing back this money into equities, at least for now. It’s more likely that these funds would find their way into the debt markets. But as equities win favour again, undoubtedly these funds will shift back to where they came from, injecting much needed liquidity in the short term. But what do these offers mean for the Indian markets over the long haul? Most open offers from MNCs are made in order to increase their stake to 100%. This will lead to the eventual delisting of their well-run, profit-making Indian subsidiaries. Domestic investors would thus be deprived of being a part of the future growth of these ventures. The delisting of these well-known, investment worthy companies will mean less choice in Indian equities for the global investor. This, in turn, will shift the spotlight to well-managed Indian companies, which might begin to attract greater investment.

Buyback Of Shares

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• • • • The Times of India Business Standard Financial Express Business Line

• • • Buyback of Shares – Ghosh Inter – CA module Financial Management- Prasanna Chandra

Buyback Of Shares


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