Good or bad? Top five reasons why companies go for share buyback

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NEW DELHI: Share buyback announcements tend to excite investors as the buyback price is usually at a premium compared with the prevailing market price at that point.

But is it really exciting news? That depends from company to company and under what circumstances a particular company has announced share buyback. One should study and analyse the offer before tendering shares.

In simple terms, share buyback means repurchase of shares by the company. It can happen in three ways –
a) either the company purchases its own shares in open market,
b) issue a tender offer and lastly,
c) negotiate a private buyback.

Let’s look at some reasons why companies go for a share buyback:

Attempt to boost earnings per share (EPS): One of the common reasons why companies go for share buyback is to boost earnings per share (EPS), because share buyback reduces outstanding shares in the market. Let’s understand this with the help of any example.

Company XYZ announces a share buyback program to repurchase, let’s say, 10 per cent of the outstanding shares at current market price.

The company had Rs 10,00,000 in earnings spread out over 1 million shares, or 10,00,000 shares, equating to EPS of Re 1.
EPS = Total Earnings/Total number of shares.

Let’s say with a PE of 30, the shares traded at Rs 30.
Market price = P/E X EPS.

Now, all else being equal, if 100,000 shares are repurchased, the new EPS would be Total Earnings/Number of shares, which in this case would become 10,00,000/9,00,000= Rs 1.11. Now, at a PE of 30, the shares would trade up by (1.11 x 30) = Rs 33.30

Reward shareholders: Another common reason for companies to go for a share buyback is to distribute excess cash to shareholders because the tender offer is usually more than the current price.

This is common practice when the market price keeps falling and there is nervousness among the shareholders either about the sector or the business itself.

This is when an investor has to analyse the offer in detail. In case, he/she is a long-term investor, tendering shares for a premium of 10-15 per cent might not make sense. In the case of TCS buyback, for instance, the buyback price is at a premium of 13.7 per cent over Monday’s closing price. Tendering share at this price would make sense only if you plan to exit the stock in the near term.

“TCS is still a good bet in this space and the stock is not expensive considering the enormous negative sentiment around the industry. Things are unlikely to go worse from here,” Pankaj Sharma, an independent market expert, told ETMarkets.com.

Undervalued shares: At times when the company feels the shares are undervalued, a share buyback is used to pump up the stock price, which acts like a support or new base for the stock.

There could be a number of reasons why shares of a particular company are trading lower despite stable fundamentals. A buyback reassures investors that the company has confidence in itself and is determined to work towards creating value for shareholders.

Lack of growth opportunities: This is a controversial point, but quite relevant, especially in the case of IT industry, which has quite a lot of cash on the books but has fewer growth opportunities. TCS has a cash pile of Rs 43,169 crore, which is nearly 10 per cent of the company’s market capitalisation.

Recently, Cognizant too announced a $3.4 billion buyback plan. Infosys had liquid assets, including cash and cash equivalents and investments, worth Rs 35,697 crore (about $5.25 billion) on its books at the end of December 2016.

“IT is more of a buyback story. Fundamentally, have things changed for IT? It is a low-growth market. These are value stocks. If I go back to Infosys itself, when they started last year, their guidance was closer to 13 per cent. They come down close to 8-9 per cent. We are not even sure whether they will achieve that,” Sridhar Sivaram of Enam Holdings said in an interview with ET NOW.

“IT companies in the US do large buyback which gives them about 4-5% EPS growth. In combination, they get about 10% earnings. They have a 4-5 per cent kind of growth,” he said.

Tax advantage: Share buyback makes sense for companies, because of tax arbitrage opportunities, where the programme delivers a higher value to shareholders compared to a dividend distribution.

In India, a 15 per cent tax is levied on companies distributing the dividend. In addition, the recipients have to pay 10 per cent more if dividend income exceeds Rs 10 lakh in a year, said a report. In contrast, there is no tax on long-term gains, yet.

“Most of the companies who are cash rich and they are paying a regular dividend I think they may want to go for the buyback as an option vis-à-vis the dividend payment,” Deven Choksey, KR Choksey Securities said in an interview with ET NOW.

“Largely, dividend distribution tax, as well as tax in the hands of recipient, is becoming a deterrent and as a result of which companies are basically resorting to the buyback,” he said.