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Buyback is reverse of issue of shares by a company where it offers to take back its shares owned by the investors at a specified price; this offer can be binding or optional to the investors. Why companies buyback? * Unused Cash: If they have huge cash reserves with not many new profitable projects to invest in and if the company thinks the market price of its share is undervalued. Eg. Bajaj Auto went on a massive buy back in 2000 and Reliance's recent buyback. However, companies in emerging markets like India have growth opportunities. Therefore applying this argument to these companies is not logical. This argument is valid for MNCs, which already have adequate R&D budget and presence across markets. Since their incremental growth potential limited, they can buyback shares as a reward for their shareholders. * Tax Gains Since dividends are taxed at higher rate than capital gains companies prefer buyback to reward their investors instead of distributing cash dividends, as capital gains tax is generally lower. At present, short-term capital gains are taxed at 10% and long-term capital gains are not taxed. * Market perception By buying their shares at a price higher than prevailing market price company signals that its share valuation should be higher. Eg: In October 1987 stock prices in US started crashing. Expecting further fall many companies like Citigroup, IBM et al have come out with buyback offers worth billions of dollars at prices higher than the prevailing rates thus stemming the fall. Recently the prices of RIL and REL have not fallen, as expected, despite the spat between the promoters. This is mainly attributed to the buyback offer made at higher prices. * Exit option If a company wants to exit a particular country or wants to close the company. * Escape monitoring of accounts and legal controls If a company wants to avoid the regulations of the market regulator by delisting. They avoid any public scrutiny of its books of accounts. * Show rosier financials Companies try to use buyback method to show better financial ratios. For eg. When a company uses its cash to buy stock, it reduces outstanding shares and also the assets on the balance sheet (because cash is an asset). Thus, return on assets (ROA) actually increases with reduction in assets, and return on equity (ROE) increases as there is less outstanding equity. If the company earnings are identical before and after the buyback earnings per share (EPS) and the P/E ratio would look better even though earnings did not improve. Since investors carefully scrutinize only EPS and P/E figures, an improvement could jump-start the stock. For this strategy to work in the long term, the stock should truly be undervalued. * Increase promoter's stake Some companies buyback stock to contain the dilution in promoter holding, EPS and reduction in prices arising out of the exercise of ESOPs issued to employees. Any such exercising leads to increase in outstanding
Companies can buy shares on the open market over a long-term period subject to various regulator guidelines like SEBI In both 1 & 2 promoters can participate in buyback and not in 3. Eg. Restrictions on buyback by Indian companies: Some of the features in government regulation for buyback of shares are: 1. The shares bought back should be extinguished and physically destroyed. except bonus. 5. These restrictions were imposed to restrict the companies from using the stock markets as short term money provider apart from protecting interests of small investors. etc. It may be noted that one of the risks of public listing is welcoming hostile takeovers. 3. in which companies state a range of prices at which it's willing to buy and accepts the bids. * Generally the intention is mix of any of the above * Sometimes Governments nationalize the companies by taking over it and then compensates the shareholders by buying back their shares at a predetermined price. This also gives scope to takeover bids as the share of promoters dilutes. Buyback should not exceed 25% of the total paid-up capital and free reserves 3. . 2. This is one method of market disciplining the management. Eg. Technology companies which have issued ESOPs during dotcom boom in 2000-01 have to buyback after exercise of the same. What are the methods in which buyback can happen? Share buyback can take place in 3 ways: 1. However the logic of buying back stock to protect from hostile takeovers seem not logical. conversion of warrants. Another variety of this is Dutch auction. A special resolution has to be passed in general meeting of the shareholders 2. It buys at the lowest price at which it can buy the desired number of shares. A declaration of solvency has to be filed with SEBI and Registrar Of Companies 4. it is true only when management is considered as efficient and working in the interests of the shareholders. Reserve Bank of India in 1949 by buying back the shares. The company should not make any further issue of securities within 2 years. Through book-building process.shares and to drop in prices. Shareholders are presented with a tender offer where they have the option to submit a portion of or all of their shares within a certain time period and at usually a price higher than the current market value. Though this type of buyback is touted as protecting over-all interests of the shareholders.
with a lot of publicity.Valuation of buyback: There are two ways companies determine the buyback price. . they would be deemed to have accepted it. the prima facie assumption is that the promoters have been up to tricks. and may not understand the complex legal language used in such letters. A shareholder enters a company by choice and mutual agreement and should be entitled to exit only by choice. Still this method is rarely used. in response to the offer letter sent by the company. * When the management has passed special resolutions. Note: GoI's budget of FY 2002-03 has relaxed buyback rules for the companies by which buyback of shares up to 10% of paid-up capital does not require shareholders approval thus putting the minority shareholders at the mercy of majority shareholders and promoters. Any manipulations? * Some companies come out with a scheme of buyback wherein. 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 due to speculators. it is to be noted that small shareholders generally do not bother to read such letters and respond to the same. there is enough scope for suspicion. Forcible buyback of shares at a non-transparent price would be expropriation and should be prevented. unless the shareholders rejected the offer specifically. the price is fixed at a mark up over and above the average price of the last 12-18 months. Based on the trend and value a buyback price is decided In the 2nd. while the top of the price range is set at a premium to the market price. If there was a significant rise. They use the average closing price (which is a weighted average for volume) for a period immediately before to the buyback announcement. Eg. The low point of the range is at a discount to the market price. Investors are given more say in the buyback price than in the above arrangement. * Some companies make it compulsory for shareholders to sell at a specified price mandated by the company. empowering the Board to buy back whenever allowed. MNCs listed on exchanges have taken this route in a big way in 2001-2003 Checklist for investors before accepting the company's buyback offer: * Take a look at the share price movement immediately before the buyback. Generally. * Debt-equity ratio: The companies aare hugely under debts are unlikely to have free cash * Companies that have just come to the capital markets to raise money are unlikely to be good candidates for buyback. Though courts have upheld the action of the companies. shareholders are invited to sell some or all of their shares within a set price range.
" a company release said.35 per cent on the Bombay Stock Exchange. . Total operating income of the company rose to Rs 3.000 cr worth shares at Rs 725/piece New Delhi. Reliance Infra will buy-back shares up to a maximum price of Rs 725.87 crore for the same period last year. it added. Shares of the company were trading at Rs 624.25 crore. Reliance Infra today posted a 10. Eg: It was feared in 2001-03 that de-listing by many MNCs may drop the money flow to stock exchanges.000 crore. Rel Infra to buy back Rs 1.000 crore worth of shares at a price of Rs 725 a piece. Meanwhile. Feb 14 (PTI) Anil Ambani-led Reliance Infrastructure today said it would buy back Rs 1. Conclusion It may be remembered that buyback has no impact on the fundamentals of the economy or the company. a premium of approximately 17 per cent to the last closing share price. The company had reported a net profit of Rs 367. Therefore investors should be cautious of unscrupulous promoters' traps. This may also lead to reduction in investor interest in the market particularly with de-listing of good shares.Effect of buybacks on stock exchanges: Buyback may leads to abnormal increase of prices posing heavy risk to those who value shares based on fundamentals.287 crore in the corresponding quarter a year ago. "Board of Directors of Reliance Infrastructure today approved a buy-back of its outstanding shares for an aggregate amount of up to Rs 1. up 1. it said.16 per cent rise in net profit for the quarter ended December 31. 2010.744 crore in the OctoberDecember quarter from Rs 3. to Rs 405. The company has done three buy backs for an aggregate amount of Rs 923 crore.
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