Corporate share buyback is an effective tool to prevent companies’ share prices from devaluation and re-instilling promoter confidence. As the number of share buybacks climb, the debate over the concept heats up further.

In June 2013, the Securities & Exchange Board of India (SEBI), the Indian capital market regulator, did what was most desired by investors and shareholders. It raised the total buyback quantity to 50% of the company’s total buyback offer size, while simultaneously reducing the period of buyback to six months from the earlier period of one year. Moreover, it states that share buybacks upwards of 15% of the company’s total share capital will have to be made through a tender offer, besides also restricting companies from raising funds from the market for one year following the share buyback.

The step seems to have been taken at the right time. Revised guidelines regarding corporate share buybacks will ensure regulation in pricing, quantity and periodicity aspects of buyback offers. The revised guidelines will ensure companies make genuine share buyback offers and do not use them as a tool to prop up their stock prices.

In the past, companies have kept share buyback offers open for as long as a year, without actually buying a single share. Moreover, of the 75 buyback cases in the past three years, most companies touched less than 50% of their target for buyback.

In the backdrop of continued volatility in Indian stock markets, uncertain economic environment, sluggish business prospects, and weak consumer and investor sentiments, companies are increasingly resorting to share buyback as a tool to restore investor confidence in the company and its growth prospects.

WHAT ARE SHARE BUYBACKS?

Share buyback is one of the most important tools a company uses for its financial restructuring. It effectively re-engineers the company’s capital structure, reduces its capital employed and balance sheet, and at the same time, increases its earnings per share, dividend per share, return on equity and return on assets.[/vc_column_text]

A corporate share buyback is usually attempted by a company when it has surplus cash after incorporating the future investment opportunities into its corporate strategy.

Revised guidelines regarding corporate share buybacks will ensure regulation in pricing, quantity and periodicity aspects of buyback offers. The revised guidelines will ensure companies make genuine share buyback offers and do not use them as a tool to prop up their stock prices.

Buyback of shares at a premium to their current market price sends out a strong signal to shareholders on the stock price’s undervaluation and displays the management’s conviction in the company. Companies often prefer to utilise corporate cash for share buybacks versus paying dividends or investing the piles of cash in the business.

As the move results in an increase in promoter’s stake, it reinforces their promoter’s confidence in the company’s fundamentals and future potential.

Investors usually favour share buybacks on two conditions are met. First, when a company has ample funds to take care of the operational and liquidity needs of its business; and second, when the stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.

NEW GUIDELINES ON CORPORATE SHARE BUYBACK AND SEBI’s RATIONALE FOR REVISON

When a company buys back shares by reinvesting their own capital into the company, it reinforces their confidence in the company’s business, thus helping prop up the share price.

In the event of the number of outstanding shares decreasing due to a share buyback, the shareholder value or Earnings Per Share of the stock increases. Companies often continue to protect their earnings by buying back the number of shares necessary to prevent earnings dilution.

ADVANTAGES OF SHARE BUYBACKS

Let us take a look at the benefits a share buyback can have.

a. Sizeable Cash:
Companies sitting on piles of cash are often under pressure to return the value to the shareholders. Share buybacks send out a positive signal to investors. When a company announcing share buyback has sizeable cash reserves, it is utilised to buyback shares at a premium to the market price, giving a strong indication to markets that the stock is undervalued. Share buybacks also help in reducing the number of outstanding shares and in improving the Earnings Per Share, return ratios, and the balance sheet.

b. Rising Share Prices:
When a company buys back shares by reinvesting their own capital into the company, it reinforces their confidence in the company’s business, thus helping to prop up the share price. Citing a recent example, the stock of FMCG player Hindustan Unilever Ltd was quoting at ` 583.80 on April 30, 2013, the day of its share buyback announcement. The company announced its intention to buy shares from the market at ` 600 a share, a premium to the then quoting share price. A month after the buyback announcement, the share price surged to ` 595.60 a share.

c. Increased Shareholder Value:
One way to measure the companies making prudent share buybacks is to compare the valuations at which they pay for their own shares to the stock’s historical median valuation. In the event of the number of outstanding shares decreasing due to a share buyback, the shareholder value or Earnings Per Share of the stock increases. Companies often continue to protect their earnings by buying back the number of shares necessary to prevent earnings dilution.

d. Increased Float:
As the outstanding share count of the company decreases, the remaining shares represent a larger percentage of the float. If demand for the stock increases and there is less supply of stock, it leads to an upward movement in the price of the stock. Fewer outstanding shares means the remaining shares are worth more. The value of the stock changes as there are now fewer shares outstanding.

Authored by:

Manoj Saha
Managing Director
Dickenson World

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