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BUY BACK OF SHARES
UNIVERSITY OF MUMBAI
ADITYA SUNIL BAGARKA
T. Y. B.M.S.
TOLANI COLLEGE OF COMMERCE
ANDHERI (EAST), MUMBAI – 400 093
I, Mrs. Shalini Hemant, hereby certify that Mr. Aditya Bagarka of Tolani College of Commerce, T.Y. B.M.S. (Semester V) has completed his project titled BUY BACK OF SHARES in the academic year 2005-2006. The information submitted herein is true and original to the best of my knowledge.
Mrs. Shalini Hemant (Project Guide)
Dr. A. A. Rashid (BMS Co-ordinator)
Dr. Sheela Purohit (Principal)
I, Aditya Bagarka, of Tolani College of Commerce, T.Y. B.M.S. (Semester V) hereby declare that I have completed my project titled BUY BACK OF SHARES in the academic year 2005-2006. The information submitted herein is true and original to the best of my knowledge.
Place: MUMBAI Date:
At the onset, I would like to thank the almighty who gave me determination and patience throughout the compilation of this project.
Further, I would like to thank Mrs. Shalini Hemant for her help and guidance without which this project would not have reached this point.
There is one person who has been a constant source of encouragement and help, Mrs. Akshata Kadam, I hereby acknowledge all her efforts.
My parents and family has been a great source of motivation for me always; I am deeply indebted with all the help and facilities they provided me with.
I would like to extend my gratitude to all the people whom I contacted with, during the process of collecting information, for their valuable time and efforts in explaining me the concept of BUY BACK.
Lastly, I thank all my friends for their support in all the possible ways.
I sincerely hope that the project lives up to your expectations.
1. To analyse the process of buy back and motives behind buyback
2. To analyse impact of buyback
3. To find out the sources and ways of buyback
4. To analyse the obligations of company resorting to buyback
5. To analyse the pitfalls in buyback
6. To analyse the buyback modus-operandi in India with the help of case study
Table of Contents
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
Introduction - The Indian Capital Market Buy Back of Shares Objectives Sources Methods Public Announcements Extinguishment of Certificate Leveraged Buy Back Pricing Buy Back Tax Implications General Obligations Buy Back in India Recommendations & Findings Pitfalls Case : Berger Paints The Bottomline
1–2 3–5 6–9 10 – 12 13 – 20 21 – 23 24 25 – 28 29 – 32 33 – 35 36 – 37 38 – 42 43 – 48 49 50 – 57 58 – 60
— Buy Back of Shares
Introduction – 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.
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
— Buy Back of Shares 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 MNCs 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.
— Buy Back of Shares
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.
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 objective of buying back of own shares by companies. Buy back offers a straight route for swapping equity for debt. In a situation when equity appears to be costlier to debt, this ..3..
— Buy Back of Shares would help to reduce overall 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
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. Board of directors is the custodian of shareholder’s money. If it cannot add better value or, 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.
— Buy Back of Shares Restrictions that have 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 of 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.
However, it is not an easy route. It requires an order of court, which in turn requires fulfillment of the following conditions: • • • The 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. It cannot be exercised as a financial strategy. To the contrary, buy back is a flexible approach by which a company can safeguard payment of outside liabilities before exercising buy back.
— Buy Back of Shares
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 improves 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 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
— Buy Back of Shares 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:
Promoters : 30% FIs Public : 25% : 45%
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.
— Buy Back of Shares 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: • 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.
— Buy Back of Shares 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: • 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 Firstly, 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.
Secondly, 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.
— Buy Back of Shares
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.
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.
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.
— Buy Back of Shares 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 by issue of any pure or hybrid debt instruments.
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?
— Buy Back of Shares • • 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
Section 77A (2) of the Companies Act, 1956 requires that buy back should be carried out if: • • • Authorized 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.
— Buy Back of Shares
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. classified as open market buyback. Such transactions cannot be
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. Buy back is not allowed through spot transactions or through any private arrangement.
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.
— Buy Back of Shares
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.
(I) For the purposes of passing a special resolution under sub-section (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. (II) 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.
A company may buyback its shares by any one of the following methods –
a. From open market; b. From the existing shares on a proportionate basis through the tender offer
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
— Buy Back of Shares
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 The company and the merchant banker shall give the information to the stock exchange on a daily basis regarding the shares purchased for buyback 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: • 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
— Buy Back of Shares exchange. • • • The company shall appoint a merchant banker and make a public announcement in reference to the same. The public announcement shall be made at least seven days prior to the commencement of buy-back. 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. • 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. • The public announcement shall also contain the detailed methodology of the book-building process, the manner of acceptance, the format of acceptance to be sent by the shareholders pursuant to the public announcement and the details of bidding centers. • • The book building process shall be made through an electronically linked transparent facility. The number of bidding centers shall not be less than thirty and there shall be at least one electronically linked computer terminal at all the bidding centers. • • • The offer for buy back shall remain open to the shareholders for a period not less than fifteen days and not exceeding thirty days. The merchant banker and the company shall determine the buy-back price based on the acceptances received. 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.
— Buy Back of Shares
BUY-BACK 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. b. • • The price at which the buy-back of shares shall be made; 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 six-months 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. 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. ..17..
— Buy Back of Shares 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). 7. 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. 8. 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. 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.
— Buy Back of Shares 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 manner• • If 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. 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 cash
— Buy Back of Shares 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 non-fulfillment 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.
— Buy Back of Shares
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.
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
— Buy Back of Shares 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 certificate 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. 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 unaudited 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
— Buy Back of Shares 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. 14. 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.
— Buy Back of Shares
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 dematerialized shall be extinguished and destroyed in the manner specified under Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996 and the bye-laws framed there 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. • 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,
— Buy Back of Shares
Leveraged Buy Back
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 • 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
— Buy Back of Shares 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. • 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.
— Buy Back of Shares Conditions for Leveraged Buy Back Since equity is costlier to debt, the management may think for buy back equity through issue of debt instrument. What should be the precondition of leveraged buy back? − Debt servicing coverage of the company should be good; − Free cash flow to debt coverage is good; − Business risk is moderate.
Debt service coverage ratio is given by – Cash 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. Cash flow from operating activities is determined before charging depreciation and other non-cash expenses and losses.
A successful leveraged buy back is dependent on many factors •
Pre-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. Even if old debt cannot be repaid because of high premium 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. 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
— Buy Back of Shares 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.
— Buy Back of Shares
Pricing Buy Back
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 – − Asset backing value; − Profit Earning, Capacity Value − Market value.
Weights are chosen in accordance with financial position and profit-ability of the company.
— Buy Back of Shares 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
Steps to be followed in determining net assets available to the equity shareholders are – • Determination 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. Whatever the company has spent on intangibles that has value only if it can generate additional operating profit.
— Buy Back of Shares 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. 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. automatic provisioning of current assets. • • Miscellaneous expenditure and losses should be excluded. All liabilities should be taken at the redemption value. This will make
— Buy Back of Shares 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 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. 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.
— Buy Back of Shares
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 well 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.
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
— Buy Back of Shares 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.
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.
— Buy Back of Shares 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 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.
— Buy Back of Shares
General obligations of a company 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. • 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. The promoters and persons having controlling interest cannot
participate in the buy back through stock exchange 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
— Buy Back of Shares 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.
Publication of buy back information
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.
— Buy Back of Shares
Buyback in India
Buyback is essentially meant to be a financial tool in the hands of the corporate to acquire the required flexibility in their capital structure & financial position, keeping in view the needs of the business as well as a tool to defend the co. from takeovers.
Internationally, it has been observed that companies have opted for Buyback in times when they believed that shares were undervalued in the market or when they had surplus cash in their treasury. E.g. In 1997, Coca-Cola opted for Buyback of 8.3% of their equity that raised the price of the scrip by a whopping 42% in the NYSE. Major global companies that have opted for buyback in the last couple of years include IBM, HP, Washington Post, Nestle, etc.
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 company 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.
— Buy Back of Shares
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 shareholders).
In India though many specified group companies 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 companies like Reliance 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 companies have a Debt-Equity ratio greater than one. Buyback would definitely increase this ratio & reduce the leveraging capacity of the company. This is specially applicable to companies having a high proportion of fixed assets, like TISCO & TELCO. Coupled with the fact that the company will not be able to issue new shares for at least one year, this implies that the company 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 wardaway 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, companies are allowed to borrow to buy back their shares in case of a takeover bid.
However in India a company is not allowed to undertake fresh borrowings for the purpose of Buyback. This means that weaker companies which are inevitably takeover targets cannot resort to Buyback as a defense mechanism.
— Buy Back of Shares
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.
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.
— Buy Back of Shares
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 identified four cash rich oil PSUs, namely, IOC, BPCL, ONGC and GAIL, for the first trench of buy back. The PSUs have huge accumulated 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.
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
— Buy Back of Shares 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.
Buybacks done by companies
Reckitt Benckiser Cadbury India Ltd. CG Glass Ltd. (Philips) Otis Elevator Co. (I) Ltd. Carrier Aircon Ltd. International Best Foods (HLL) Philips India Ltd. Detergents India Ltd. (Henkel)
Buy Back Month
March 2002 January 2002 September 2001 July 2001 July 2001 November 2000 November 2000 December 1999
400.0 874.9 13.1 109.2 114.8 24.9 234.3 1.1
Indian Companies Company
Exide Indutries Bombay Dyeing Balarampur Chinni Mills Ltd. Hindalco Reliance Industries Ltd. Jayshree Tea & Industries Ltd. John Fowler GE Shipping Kesoram Industries Bhagyanagar Metals Ltd. Godrej Consumer Products Ltd. Blue Star Ltd. Heritage Foods Siemens Finolex Industries
Buy Back Date
7-Jan-02 20-Aug-02 21-Jan-02 30-Jan-02 31-Jul-01 24-May-01 25-Nov-01 23-Aug-01 9-Oct-01 1-Oct-01 21-Jan-02 15-Feb-02 24-Jan-02 25-Jun-01 26-Apr-01
Total No. of Shares
263,586 1,826,954 NA 5,807 NA 402,034 129,990 13,336,499 4,590,635 349,089 748,482 625,105 66,701 2,355,794 19,992,840
Buy Back Price
70 60 100 826 303 75 62.5 42 40 65 4 75 30 250 40
— Buy Back of Shares
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.
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 ..43..
— Buy Back of Shares 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.
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 ..44..
— Buy Back of Shares 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. •
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.
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.
— Buy Back of Shares
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 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.
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, postbuyback, 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.
— Buy Back of Shares
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 on RoE and also assess its future earnings potential before choosing to stay on as a residual shareholder in it.
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 2001, 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,
— Buy Back of Shares 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 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 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.
— Buy Back of Shares
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 gets highly leveraged and changes the shareholders perception of the company from being an income stock to a growth stock.
— Buy Back of Shares
The Company was incorporated on 17 December, 1923, in the state of West Bengal as Hadfields (India) Limited. The name of the Company was changed to British Paints (India) Ltd. on acquisition of the Company by British Paints (Holdings), U.K in 1947. The foreign shareholding in the Company changed hands and finally rested with Berger Jenson Nicholson Limited, U.K. In 1976, the foreign shareholding in the Company was diluted to below 40% by sale of a portion of the shares to the UB Group. On and from 31 December, 1983 the name of the Company was changed to Berger Paints India Limited. In 1991, the stake of the UB Group in the Company was purchased by the present promoters. The promoters, viz. Shri K S Dhingra, Shri G S Dhingra , their relatives and companies controlled by them, currently hold 73.53% of the paid-up capital of the Company.
The Company is an existing profit making company having an uninterrupted dividend record since 1981. The Company is presently engaged in the manufacture and sale of paints, varnishes and enamels and powder coatings. The erstwhile Rajdoot Paints Limited was merged with the Company effective 1 October, 1998 and the erstwhile Berger Auto & Industrial Coatings Limited was merged with the Company effective 1 April, 2004. The Company has an extensive distribution network consisting of depots located all over the country and over 10000 dealers.
The Company also supplies a wide range of products to both the industrial and the architectural segments. The Company has a number of technology tie-ups for various high technology paint ranges.
— Buy Back of Shares The brief audited financial information of the Company for the last three financial years and unaudited financial information of the Company for the nine months ended 31 December, 2004 are given below:
(Rs. In Lakhs) Particulars Year ended 31/03/2002 (audited) Year ended 31/03/2003 (audited) Year ended 31/03/2004 (audited) Nine Months ended 31/12/2004 (unaudited) Gross Turnover Net Turnover Total Income Profit before Interest, Depreciation, Exceptional Item and Tax Profit After Tax Equity Dividend Paid-up Equity Share Capital Reserves & Surplus Networth Key Ratios Earning Per Share (EPS) Rs. Book Value Per Share (Rs.) Debt/Equity Ratio RONW (%) 1.58 7.51 0.50:1 20.97 1.68 8.28 0.23:1 20.26 2.21 9.30 0.21:1 23.76 1.83 60165 52912 53221 66842 58643 58900 77030 67582 68100 69994 61006 61287
3139 1329 2657 12600 14971
3342 1594 2657 14129 16499
4403 2126 2657 16120 18534
— Buy Back of Shares
Necessity for Buy Back
The Company has substantial reserves deployed in various assets and it is expected to keep generating sufficient cash flows to meet the requirements of present business while assuring adequate return to its stakeholders. Accordingly, an offer for buy-back of shares, which will provide an exit opportunity to those shareholders who so desire, in a manner that does not substantially impact the market price of the Company’s shares, has been made. This is expected to enhance the Earning Per Share (EPS) of the Company in future and create long-term share value.
Disclosures Contained in the public notice issued after the Board Meeting held on 29 April, 2005 1. The Board of Directors of Berger Paints India Limited at its meeting held on 29 April, 2005 approved the proposal for buy-back of the Company’s own fully equity shares of Rs. 2/- each in accordance with the provisions contained in the Articles of Association of the Company, Sections 77A, 77B and other applicable provisions of the Companies Act, 1956 and the provisions contained in the Buy-Back Regulations. 2. The Board had proposed the buy-back to the extent of or less than 10% of the paid up equity capital and free reserves of the Company which shall, however, not exceed 25% of the paid up equity capital of the Company, at a price not exceeding Rs. 60/- per equity share and the total amount of consideration not exceeding Rs. 1859 lakhs. 3. The Article 3A of the Articles of Association of the Company permits the Company to buy-back its own shares. 4. An offer for buy-back of shares, which will provide an exit opportunity to those shareholders who so desire, in a manner that does not substantially impact the market price of the Company’s shares, has been made. This will enhance the Earning Per Share (EPS) of the Company in future and create long term share value.
5. The buy-back was proposed to be implemented by the Company by way
of open market purchases through the National Stock Exchange of India
— Buy Back of Shares Limited (NSE). The Company had not buy-back its equity shares from any person through negotiated deals whether on or off the Stock Exchange(s) or through spot transactions or through any private arrangement in the implementation of the buyback. 6. The maximum amount required by the Company for the said buy-back aggregating Rs. 1859 lakhs was met out of the free reserves and/or the share premium account of the Company.
7. The maximum offer price was arrived after taking into consideration
various factors including,, Earning Per Share in the last three years, Industry average price earning ratio, book value, average of share prices in the preceding weeks and other relevant factors. The maximum buy-back price as proposed above will not impair the growth of the Company and also contribute to the overall enhancement of shareholder value. 8. The number of equity shares bought back would depend upon the average price paid for the equity shares bought back and the aggregate consideration paid for such equity shares bought back. As an illustration, at the proposed maximum offer price of Rs. 60/- per equity share and for an aggregate consideration amount of Rs.1859 lakhs, the maximum number of equity shares that can be bought back would be 3098333 equity shares aggregating approximately 1.56% of the total paid up equity shares as on 29 April 2005. 9. The aggregate shareholding of the promoters as on 29 April 2005 is 146543273 equity shares constituting 73.53 % of the listed share capital of the Company. 10. The promoters of the Company have neither purchased nor sold any shares during the period of six months preceding 29 April, 2005 being the date of the Board Meeting at which the buy-back was approved except the following: Share purchased - 1009924 equity shares including inter se transactions among promoters. The maximum purchase price was Rs. 37.00 on 2 February, 2005 and the minimum purchase price was Rs. 30.75 on 9 November, 2004 Shares Sold - 89620 equity shares representing inter se sale among promoters only. The sale price was Rs. 37.00 on 2 February, 2005. ..53..
— Buy Back of Shares 11. The debt equity ratio of the Company after the buy-back was within the limit of 2:1 as prescribed under the Companies Act, 1956.
Present Capital Structure and Shareholding Pattern
The Share Capital of the Company as on 29 April, is as follows:
CAPITAL Authorized: 200,000,000 Equity Shares of Rs 2/- each Issued: 199,345,230 Equity Shares of Rs. 2/- each Subscribed: 199,293,990 Equity Shares of Rs. 2/- each Fully paid-up
Equity Share Capital Rs. ‘000
Less: Calls unpaid
— Buy Back of Shares The present shareholding pattern of the Company at opening of business hours on 2 May, 2005 is as shown below:
Particulars No. of equity shares % of existing Equity Capital No. of shares post buyback % holding post buyback
persons who are in control Persons and/or acting in
concert with them Institutional Investors (Banks, 14489925 7.27 14489925 7.39
Mutual Funds, FIs, FIIs) Others Corporate Indian NRIs/OCBs) Total 199293990 100 196195657 100 (Private 38260792 Bodies, Public, 19.20 35162459 17.92
— Buy Back of Shares
Process & methodology adopted for Buy Back
a. The buy-back was open to all equity shareholders of the Company both registered and unregistered holding shares either in physical and / or electronic form, except promoters.
b. As per the Buy-Back Regulations, a company intending to purchase its shares from the open market, shall do so only on the Stock Exchange(s) having nationwide trading terminals. Accordingly, the buy-back was implemented by the Company by way of open market purchases through NSE using its nationwide electronic trading terminals. c. For the aforesaid buy-back of equity shares, the Company has appointed the following registered broker (“Broker to the Offer”) through whom the purchases and settlement on account of buy-back would be made
ARK Securities Private Limited 73, Khan Market, Ist Floor, New Delhi – 110 003
— Buy Back of Shares
Impact of the Buy Back on the Company
The buy-back had caused any material impact on the profitability of the Company. The buy-back had not impaired the growth of the Company and also contributes to the overall enhancement of shareholder value.
The Company is capable of generating sufficient cash flows to meet the requirements of the present business as well as assuring adequate return to its stakeholders. The Company may also continue to avail financial assistance from banks/financial institutions for meeting its business requirements.
Pursuant to Regulation 15(b) of the Buy-Back Regulations, the promoters and persons in control are not entitled to offer equity shares held by them under the buy-back. Post buy-back, the holding of the promoters and persons in control would be 74.69% of the total equity capital assuming that the entire amount of Rs. 1859 lakhs is utilized for the buy-back and the equity shares are bought back at the maximum price of Rs. 60/- per share. The buy-back had not affected the existing management structure. Post buy-back, the debt equity ratio of the Company will be within the limit of 2:1 as prescribed under the Companies Act.
— Buy Back of Shares
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.
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 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
— Buy Back of Shares • 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 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 attempts at
— Buy Back of Shares "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.
• • • • • • • www.blonnet.com www.vckgroup.com www.advanishares.com www.indiainfoline.com www.rediff.com www.indiaheadlines.com www.indiainfo.com
• • • • The Times of India Business Standard Financial Express Business Line
• • • • Buyback of Shares – Ghosh Inter – CA module II Financial Management- Prasanna Chandra Financial Management- Khan & Jain
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