Buyback

ATHENE INSIGHTS

Tata Consultancy Services Ltd

Size: Amount Size: % of shares Price
₹ 16,000 cr 1.42% ₹ 3,000

Disclaimer: This document has been prepared by Athene Capital Advisors LLP (“Athene”) for information purposes only,
based on publicly available data. It is not an offer to sell, or a solicitation of an offer to buy, nor to enter into any agreement
or contract with Athene. Athene shall not have any liability whatsoever to any person on account of the use of information
provided herein. Athene does not guarantee or make any representation, express or implied, with respect to the fairness,
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Buyback
TCS BUYBACK EXPLAINED
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Athene Insights

TCS recently announced a Rs. 16,000 crores buyback. 5.33 crore shares
(1.42% of current total shares outstanding) are to be bought back from
shareholders by TCS at a price of Rs. 3,000, which is a ~20% premium to the
unaffected price. As of September 30, 2020 TCS had cash & equivalents of
~Rs. 47,000 crores. So, the Rs. 1,6000 crores amounts to a distribution of a
whopping ~34% of TCS cash to its shareholders.

In addition to the buyback, TCS has also announced a dividend of ~Rs.

4,500 crores. Tata Sons holds ~72% in TCS currently and therefore will be
receiving a significant portion of the Rs. 20,500 crores dual distribution. The
key use of the proceeds is likely to be the purchase of Tata Sons’ stake from
Shapoorji Pallonji due to the ongoing feud between the two parties.

TCS, being a highly profitable, significant cashflow generating IT business
has always acted as the cash-cow for Tata Sons. Whenever Tata Sons had
significant cash requirements, they have resorted to some sort of a large
monetisation transaction involving TCS. In March 2018, Tata Sons sold a
1.48% stake in TCS for ~Rs. 8,000 crores for paying off debt in some of the
group companies. In May 2017, TCS had undertaken a buyback of Rs. 15,999
crores, of which Tata Sons, as the largest shareholder, received ~Rs. 10,000
crores which was used to fund other group companies.

Such a large buyback by TCS is going to create investor pressure on other
cash rich IT companies as well to undertake similar buybacks. Therefore, we
expect few more of such buyback announcements in the coming months.

With this backdrop, let us explore the concept of buybacks in detail. For the
purpose of this analysis, we will focus on buybacks by company (not by
promoters) and through tender offer process (not through open market).

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Buyback
WHAT ARE BUYBACKS?
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Athene Insights

Buyback, as the term suggests, is the process through which a company

buys its own shares back from its shareholders. Over the last few years,
buybacks have increasingly become a preferred method of companies,
especially in USA, to return cash to its shareholders instead of paying out
large dividends. In India as well, buybacks have been common and are likely
to get more popular due to recent changes in tax laws.

How are buybacks different from dividends?
Buybacks and Dividends are typically the two ways by which companies
return cash to shareholders. Capital reduction is a third way in India but it’s
too obscure and we will ignore it here for this discussion. There are
significant differences between buybacks and dividends.

ª  Buybacks need regulatory (SEBI) approval in India. Dividend payouts
do not need any such approvals.
ª  Buybacks are discretionary – shareholders choose whether they would
participate in the offer whereas dividends are not discretionary –
everyone who is a shareholder gets the dividend.
ª  Buybacks can change a company’s shareholding depending on
participation by shareholders in the buyback offer. Dividends have no
impact on shareholding.
ª  Buybacks lead to reduction in number of shares outstanding – which
increases the earnings per share (EPS) of the company. Dividends have
no impact on a company’s EPS.
ª  Buyback regulations have several restrictive clauses including
prohibiting a company from raising fresh capital for a period of 6
months post completion of buyback. Dividends have no such onerous
restrictions.

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Buyback WHY DO COMPANIES UNDERTAKE
BUYBACKS? Athene Insights
Athene Insights
Tax: In most cases, companies choose buyback as a means to distribute
cash to shareholders because they are more tax efficient than dividends. In
India, dividends are taxed at an investor’s marginal tax rate. However, in
case of a buyback, companies need to pay a distribution tax and there is no
further tax in the hands of investors. Since for most listed Indian
companies, promoters hold a big chunk of shareholding and are likely to
suffer significant tax incidence in case of a large dividend receipt from the
company, buybacks become a tax efficient way for promoters to receive
cash distribution from the company. The huge difference in tax incidence
will become clear with the following example:
Dividend Buyback
Total cash available with the company for distribution 100 100
Distribution tax paid by the company 0 18.9(1)
Income tax paid by shareholder 35.9(2) 0
Net cash received by shareholder 64.1 81.1
(1) 20% distribution tax rate +12% surcharge+4% cess to be paid on the net amount received by the shareholder
(2) 30% tax rate + 15% surcharge + 4% cess for a shareholder in the highest tax bracket

As you can see from the illustration above, buyback can lead to a 25%
higher post tax payout for a shareholder in the highest tax bracket.

Increase in promoter shareholding: Given that buybacks are discretionary,

not all shareholders participate in a buyback offer and therefore the post-
buyback % holding of investors who do not participate increases. Buyback
offers can be a way for promoters to increase their shareholding in a
company. To take an example, assume that there are 100 shares of a
company of which promoter owns 60 (60%). The company announces a
buyback of 10 shares from public shareholders, which is fully subscribed.
Post the buyback, the promoter will have 60/90 i.e. 66.7% shareholding in
the company.

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Buyback WHY DO COMPANIES UNDERTAKE
BUYBACKS? Athene Insights
Athene Insights
Price support: Dividend payout ratio of a company generally stays stable from
year to year. As a result, dividends are an “expected event” and are typically
already baked into the stock price. Further, as per theory, post dividend payout,
a company’s stock price should reduce by the quantum of dividend paid per
share. Stocks often correct once they go ex-dividend. In comparison, buybacks
are typically one-off in nature and are therefore not baked into the stock price.
The unexpected nature of buybacks often leads to a company’s stock price
reacting sharply to a buyback announcement. When buyback is announced at a
good premium to the prevailing price, it can have a positive impact on the stock
price. Further, buybacks lead to reduction in number of shares outstanding –
which increases the earnings per share (EPS) – this in turn can boost the stock
price in the long term if P/E ratio remains unchanged. Buybacks, when large in
size, can significantly reduce the cash balance on the books of a company. Cash
is generally a less productive asset for companies as safely invested cash earns
considerably lesser returns than what can be earned by reinvesting it in business.
So a reduction of cash balance, alongside reduction in equity base due to
buyback also improves Return on Equity (ROE) metric, which acts as an
additional positive support for the stock price. Large buybacks at a premium
can thus be a useful tool for the management to support company’s stock price.

Signaling: Buyback also is an indicator of company management’s view on stock
price. After all, the insider management team is supposed to know a company’s
prospects the best and a decision to buy the company’s stock indicates that
management believes that the current stock price levels undervalue the
company. The signaling is strongest when promoters/controlling shareholders
do not participate in the buyback offer.

Capital return: As theory goes, management is supposed to deploy a company’s
capital resources in a manner that is in the best interest of its shareholders.
Management will generally prioritise business growth through either capital
expenditure or acquisitions. Therefore, when a large buyback is announced, it is
an indication that management did not find attractive opportunities to deploy
the company’s cash into new growth investments and instead prefers to return
excess cash to shareholders.
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Buyback HOW SHOULD INVESTORS EVALUATE
BUYBACKS? Athene Insights
Athene Insights
In order to decide whether to participate in a buyback offer, investors need
to look at (i) rationale for the buyback offer and (ii) buyback offer price.

To understand the primary rationale behind the offer, an investor should
check (a) whether promoters are participating in the offer and (b) size of
the offer as as % of company’s current shares outstanding. Regulations in
India require that in a buyback announcement, promoters explicitly declare
upfront whether they will be participating in the buyback offer and how
many shares will they tender. The below table summarises various buyback
offer scenarios, as per their rationale.

Promoter
Scenario Offer size
participation
Implied offer rationale
1
Small
Yes Tax efficient dividend payout
(<5% of equity capital)
Large Tax efficient dividend payout / Absence of
2 Yes
(>5% of equity capital) significant growth investment opportunities
Small Price support, with promoters increasing
3 (<5% of equity capital)
No
stake
Large Promoters signaling that company is
4 (>5% of equity capital)
No
significantly undervalued

Having established the offer rationale, the next step is to check how
attractive the buyback pricing is. The below table summarises the
recommended investor action based on pricing.

Buyback price at a
Scenario significant premium to Buyback price at a small Buyback price less than
premium to market price market price
market price
1
2 Should participate Should participate only if
Should participate post-tax market price is
3 Should not participate less than the buyback price
4

Let us evaluate each of the above cases in detail in the next section.
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Buyback HOW SHOULD INVESTORS EVALUATE
BUYBACKS? Athene Insights
Athene Insights
If the pricing is at a significant premium to the market price, it is generally
advisable to participate in the buyback offer, irrespective of the rationale
of the offer. Most other shareholders are also likely to be participating in
such an offer and therefore it is unlikely that there will be any significant
change in the post offer shareholding of the company. Therefore, the non-
participating shareholder is not going to gain significantly in terms of
shareholding % and hence he/she is better off getting his/her share of the
cash being distributed. In some cases, if post buyback price corrects to its
pre buyback levels, investors may even be able to replenish their holding in
the company by buying shares from the market.

If the pricing is at only a slight premium to market price, the rationale of
the offer becomes a key determinant. For offers in scenarios 1 & 2, which
are effectively only dividend payouts under a different garb, investors
should consider participating for the reasons same as those explained
above. For offers in scenario 3 & 4, investors should consider not
participating since such offers indicate management and promoter’s
confidence in long-term prospects of the company as well as their
willingness to support the stock price.

If the buyback price, in the unlikely scenario, is less than the market price,
an investor should evaluate the offer carefully only if he/she was already
considering selling their shares in the company. Due to the peculiarities of
tax code, while the headline buyback price may be lesser than market price,
the post-tax price that investor gets on the market may turn out to be
lesser than buyback price. A sale under the buyback offer could thus be
more tax efficient than selling on the exchange. In such a case an investor,
who was already considering existing the stock, may be better-off
participating in the offer.

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Buyback
SUMMARISING
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Athene Insights

Having understood about buybacks now, it is clear that buybacks
are more tax efficient than dividends. However, buybacks are best
deployed by a company when the management firmly believes that
its stock is undervalued. But, in practice, buybacks are now
increasingly being undertaken purely as a cash distribution and
stock price support tool, irrespective of prevailing prices.

Warren Buffett, otherwise a fan of buybacks, is known to have
often criticized such “price agnostic” buybacks and has always
insisted that management should conduct buybacks only if the
stock price is considerably below intrinsic value. A buyback in such
a case will be a smart capital allocation decision by the
management and will be long term value-accretive to the
shareholders who don’t sell out in the buyback.

But when a rising stock price is seen as a barometer of company’s
success and has a significant impact on senior management
compensation, can you really blame them in undertaking an activity
that boosts the stock price more?

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