About Buyback of Shares: Types, process, why

Buyback of equity shares has gathered pace with many companies coming up with the buyback offers.  What is the Buyback offer?  Types of the buyback. Why do companies come up with buyback? When should a shareholder participate in the buyback of shares? What is the buyback process for Tender Offer or for Open Market Offer?

Overview of BuyBack of Shares

Buyback of shares or stock buyback refers to the corporate action where a company repurchases its own shares from the existing shareholders. There are many reasons why a company comes up with Buyback shares. During the buyback of shares, the price of shares is usually higher than the market price.

Buyback of shares can be done either through the Open market or Tender offer. 

• Open market: Under the open market mechanism, the company can buy back its shares from the secondary market. One has to sell his shares in the regular market. One may or may not get the maximum price quoted by the company. Promoters cannot take part in this route.
• Tender offer: shareholders can submit or tender portions of their shares within a stipulated time. Promoters are allowed to tender their shares in this route. The tender offer route is more attractive for shareholders as they know the premium they will get over the market price. In the open market offer, on the other hand, the company only buys when the price dips

Company will send the offer of Buyback to its investors which is open for a specific period. The investor can then choose to participate in the buyback offer. It can be done online/offline.

The Securities and Exchange Board of India (SEBI) revised the buyback regulations that stipulate 15% reservation for retail shareholders in a buyback offer. This gives retail investors a fair share in the offer, which otherwise could see large institutional investors tendering their shares leaving little or no room for small investors.

An example of buyback offer is shown in the image below.

Information about buybacks is available at the SEBI website https://www.sebi.gov.in/filings/buybacks.html an excerpt of tender offers with links is given below

Terms associated with buyback

Record date: The issuing company fixes a particular date when the investor must own shares in order to be eligible to participate in events like bonus shares , dividend, etc. This is called the record date. 

Retail Quota: The Securities and Exchange Board of Indi(SEBI) a mandates companies to set aside 15 percent of the total buyback size for retail investors, or those holding shares worth up to Rs 2 lakh on the record date, the cut-off date to decide which shareholders are eligible

Entitlement Ratio: The entitlement ratio is the number of shares offered under a buyback to the total outstanding shares of the company. For retail investors, it’s the ratio of shares tendered by such investors to the total number of shares held by this category of shareholders.

Acceptance ratio is the proportion of shares accepted to the total number of shares tendered in the buyback by investors, including promoters. The company usually stipulates that it will accept only a certain percentage of the shares you own in a buyback.  In practice, not all shareholders tender and even those who do, may not part with their entire holdings. Actual acceptance may be higher. Reservation for small shareholders can better the acceptance for such investors too.

What is the buyback process for Tender Offer?

Let’s explain the buyback process for Tender Offer using the example of Buyback offer of TCS in 2018.

Tata Consultancy Services Limited (TCS) Board of Directors of the Company at its meeting held on 15 June 2018 approved a proposal to buy back through tender offer up to 7,61,90,476 Equity Shares of the Company for a total amount not exceeding 16,000 crore( the “Buyback Size”) being 1.99% of the total paid up equity share capital, at Rs 2100  per Equity Share ( the “Buyback Price”).  The buyback — at a price of Rs 2,100 per share — accounted for 38 per cent of the IT major’s cash balance and 18 per cent of net worth.

• Firstly, to be eligible for the buyback the investor should have had shares of Tata Consultancy Services Limited (TCS) in demat or physical form as on record date 18.08.2018. 
• Sebi’s mandate that companies reserve 15 per cent of the buyback for small shareholders with holdings worth less than Rs 2 lakh. So a shareholder with a maximum of 95 shares, amounting Rs 1.99 lakh, was considered as a retail investor.
• A shareholder could participate in the buyback process which opened from [06.09.2018 to 21.09.2018], by selling his shares through the broker on NSE or BSE by filling the tender form which you can see at TCS webpage here. Excerpt of Buyback Tender offer form is shown in the image below
• Acceptance Ratio was 100%. Demat Equity Shares accepted under the Buyback were transferred to the Company’s demat escrow account on Tuesday, September 25, 2018. The unaccepted demat Equity Shares were returned to the respective Eligible Shareholders by Clearing Corporations.

What is the buyback process for Open Market Offer?

A stockholder has to sell in the market at the prevailing rate only. Price quoted by the company is not fixed price. Although the company may declare a maximum buyback price, it does not mean that the investors who sell during the buyback period will realise that maximum price. The company could actually buy in several tranches and at different prices and the entire process is executed like any other buy/sell transactions in a market.

It is also possible that they may not use the entire amount set aside for the buyback. A 2013 SEBI regulation makes it mandatory to use at least half the amount originally intended for the buyback, subject to certain exceptions such as the stock price ( i.e. volume weighted average price) moving over the maximum buyback price during the buyback period.

Example Open offer of Infosys in 2019

In Jan 2019 Infosys Technology announced buyback plan of its shares up to value of Rs 800, it means that the company will be purchasing shares from the open market at a price not exceeding Rs.800 per share.

Scenario 1– If the share price is below Rs. 800 in that case, the company will put buy order at Current Market Price and purchase shares.

Scenario 2- If the share price is above Rs. 800, in that case, the company will put buy order at Rs. 800 only and if someone is ready to sell at Rs.800 or less then only company will get back shares.

Buyback Type:	Open Market
Buyback Offer Amount:	₹ 8260
Date of Board Meeting approving the proposal:	Jan 11 2019
Date of Public Announcement:	Jan 11 2019
Buyback Offer Size:	14.54%
Buyback Number of Shares:	10.32 Cr
FV:	5
Buyback Price:	₹ 800 Per Equity Share

Example Open offer of Reliance in 2012-2013

Reliance Industries Limited (RIL) Board of Directors of the Company at its meeting held on 12 Jan 2012 approved a proposal to buy back through open market offer up to a maximum at twelve crore Equity Shares and a minimum of three crore Equity Shares of the Company. The maximum buyback price was  Rs 870 per share. Last Date for the Buy-back was January 19, 2013. 

Reason for buyback offer: Reliance had cash reserves of more than Rs 74,500 crore ($14.6 billion) at the end of 2011. Cash-rich Reliance’s share price had slumped by 35% in 2011, hit by investor concerns about slowing gas output from its fields off India’s east coast, and valuation worries about other still-to-be-explored energy assets. A share buyback was to help boost investor confidence and avoid a free-fall in the stock price.

In the year-long share repurchase programme, RIL bought back about 4.62 crore shares, estimated to be worth Rs 3,951 crore. The buyback programme had begun at a slow pace, but gained some momentum in May 2012, when the stock price fell below Rs 700. The Reliance stock had gained nearly 15 per cent during the buyback offer.

Should one participate in Buyback of shares?

Not all buyback offers are good. While many consider a buyback to be a low-risk way to deploy extra cash, there are downsides. There is empirical evidence available across countries and markets that sometimes buybacks are a short-cut way to increase the price. It could well mean that the company undertaking the exercise has run out of good ideas. As an investor, one should look at the size of the buyback.

In markets such as the US and Europe, large institutional investors do not take kindly to companies sitting on cash and often force them to return money to shareholders through such exercises. In 2018-19 IT firms are sitting on a large amount of cash. Sentiment for the sector has soured after the Trump became president and as the business environment became tough. Hence they came out with the buyback offer.

The decision to participate in a buyback should depend on a variety of factors such as the

• Long-term prospects of the company if the long-term prospects are not healthy, and the company lacks opportunities to grow its business and is then returning money to shareholders in the form of a buyback, then one might take the buyback, assuming the premium is worthwhile.
• Nature of the investor, whether he is a fundamentals-based, long-term, buy-and-hold investor or a more active trader.

Taking a call on whether to sell and when to sell in the open market based on a buyback announcement is not an easy decision. It rather boils down to what level of returns you are happy with and how long you want to stay invested.

Why companies prefer buyback of shares and not Dividend?

Buybacks are becoming popular due to change in taxation in Budget 2016 for dividends.

If the total amount of dividend received by a shareholder in a financial year exceeds Rs 10 lakh, the amount in excess of Rs 10 lakh becomes taxable at the rate of 10 per cent, plus the applicable surcharge and cess. This is over and above the dividend distribution tax (DDT) paid by companies (effectively 20.93 per cent: DDT at 15 per cent, surcharge at 12 per cent, and cess at 3 per cent).

When the gain is short-term in nature and securities transaction tax (STT) is levied on such a transaction, the gain would be taxable at 15 per cent (plus applicable surcharge and cess),”

When the gain is long-term in nature, the buyback will have to pay long term(since 1 Apr 2018) capital gains if STT is levied and the purchase of such shares is not disqualified under Section 10(38) of the Income Tax Act.

Buyback affect on the Financial ratios

When a company buys back shares, many popular fundamental ratios are affected, even though the underlying fundamentals remain unchanged. By distorting these ratios, year-to-year comparisons become a lot less meaningful. It indirectly helps boost the share price. Because the market values a stock based on its EPS

Since the bought back shares are extinguished, the earnings per share (EPS) rises as the same profits will now be divided by a smaller equity base. 

(EPS=Net profit/number of outstanding shares)

The return on equity (ROE) also goes up, resulting in improvement of the price-to-earnings ratio (PE).

Buybacks also reduce the cash on balance sheet and hence the assets. As a result, return on assets (ROA) actually increases.

Our article, Understanding Ratios for the Fundamental Analysis of Listed Companies, explains Rations in detail

Why do companies go for buyback?

Whenever a public company generates a profit, it is left with an important decision – what to do with the additional cash. Companies have three major options available given below . Returning capital to shareholders offers an efficient way to increase value for shareholders

1. Retain earnings: allows the company to re-invest back into the business
2. Issue a dividend: Some of the money is returned back to shareholders
3. Buyback: Some of the money is returned back to shareholders

Usually, companies announce a buyback when they have no better investment plan to deploy the cash or they either feel their shares are undervalued. A buyback is a way to return cash to shareholders.

• To support share price during periods of sluggish market conditions
• To return surplus cash to shareholders. Having excess cash costs not only the company but also shareholders as cash is a kind of a ‘non-earning asset’. The company could park the excess cash in short-term instruments but that would fetch very little return. Further, a buyback announcement could send a positive signal to the stock market that the management have enough confidence in the future performance of their company.
  
• To improve Financial analysis of the company: earnings per share, return on capital, return on net worth and to enhance the long-term shareholder value;
• To provide an additional exit route to shareholders when shares are undervalued or are thinly traded;
• To enhance the consolidation of the stake in the company, To prevent unwelcome takeover bids; Under buyback, the company (not the promoters) is buying back its own shares with the excess cash generated by the business. This is as an indirect way of enhancing the controlling stake in the company. The shares bought under this schema are being kept by the company and shown in the balance sheet as a treasury stock

When can a company come up with buyback offer?

A company can use a maximum of 25% of the aggregate of its free reserves and paid-up capital for a buyback. A special resolution needs to be passed at a general meeting. However, if the company plans to use less than 10% of its reserves then only a board resolution is required.

A company cannot do a second buyback offer within one year from the date of the closure of the last buyback. Also, there are time-bound limitations on further share issuances like preferential allotment or bonus issue post a buyback. These checks have been put in place so that companies do not misuse the buyback mechanism.

Examples of Buyback

Between 1 Feb 2012 and 19 Jan 2013 Reliance Industries carried out the biggest share buyback worth Rs 10,440 crore. However, Reliance Industries bought back shares worth only over Rs 3,900 crore through open market purchases, achieving about 38 per cent of the target. The stock gained 8 per cent during the buyback period.

In 2005, Reliance Industries bought back 28,69,495 shares in a Rs 3,000 crore buyback via open market purchases. The stock had rallied 39 per cent during this period.

In 2016 state-run NMDC came out with Rs 7,527 per share buyback offer via a tender offer. The offer opened on September 19 and closed on the 30 and it mopped up 99.11 crore shares, or 123.77 per cent valid bids against 80.08 crore shares reserved in the buyback. The shares were bought back successfully at an offer price of Rs 94 per share. The stock rose 2.2 per cent during this period.

Between 23 Jan 2014 and 22 Jul 2014, Cairn India carried out a Rs 5,725 crore share buyback. But the company buy back only 36,703,839 equity shares representing 21.48 per cent of the maximum target of 170,895,522. The company paid a maximum of Rs 335 per equity and the lowest price of Rs 318 per equity share for the issue priced at Rs 335 per share. The total amount invested in the buyback was Rs 12,254 crore. That excluded any transaction costs, representing 21.41 per cent of the buyback size.  The stock gained 5.7 per cent during the buyback period.

Coal India announced a Rs 3,650 crore buyback via a tender route on a proportionate basis in 2016. The offer was open between October 3 and October 18 and the company bought back 10.9 crore shares. This stock fell 4.6 per cent during this period

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What do you think of Buyback of shares? Have you participated in Buyback of shares? In Open Market or Tender offer? Did you make money? How do you track the buyback of shares?