Mumbai: Tata Consultancy Services Ltd (TCS) said on Monday that it would buy back shares worth Rs16,000 crore at a fixed price of Rs2,850 each. This is an 18.3% premium over TCS’s share price ahead of the announcement. The company plans to buy back 56.1 million shares, or 2.85% of its equity capital.
The size of the buyback, TCS’s first and India’s largest, seems impressive, but it barely makes up for low payouts in the past.
In the six years between 2010-11 and 2015-16, TCS paid roughly 43% of its profits back to shareholders in the form of a dividend. Now, thanks to the buyback, the total payout between 2010-11 and 2016-17 will amount to around 54% of profits.
For perspective, Accenture Plc. returns nearly all of its profits back to shareholders in the form of dividends and buybacks. As a result, it enjoys a return on equity (RoE) of over 60%. Its RoE would have been much lower at 13.6%, if it hadn’t bought back the shares it did since 2003, analysts at Kotak Institutional Equities pointed out in a note to clients. In other words, relatively low payouts affect return ratios and eventually shareholder returns. TCS’s RoE stands at around 33%.
Accenture’s example shows there is a high opportunity cost for shareholders when companies hold on to excessive cash. Ironically, despite its generous payout ratios, Accenture has also managed a large number of acquisitions, and its growth in terms of incremental revenue has been far ahead of its Indian peers lately.
The key for TCS is to sustain payouts at fairly high levels, especially given the pace at which it is generating cash. After accounting for capital expenditure, TCS is expected to generate about Rs24,000 crore in free cash flow this year. Unless payouts outpace cash generation, its balance sheet will remain bloated. TCS has a cash pile of Rs43,169 crore, which is nearly 10% of the company’s market capitalization.
At the end of December 2016, cash and cash equivalents accounted for as high as 43% of its total assets, almost as high as Infosys Ltd, which is known for hoarding cash. Investors will hope that the buyback is the beginning of a new journey which results in a much leaner balance sheet. And they will also be hoping that unconfirmed reports of Infosys considering a buyback are true.
TCS’s buyback comes in the wake of a decision by Cognizant Technology Solutions Corp. to buy back shares worth $3.4 billion, after being prodded to do so by activist investor Elliott Management Corp.
With interest rates having fallen in the past few years, it has become less lucrative for companies to simply park excess cash. And with valuations having fallen, it’s cheaper to buy shares at the same time.
Buybacks are also immensely tax-efficient for shareholders. For stocks that have been held for over a year, the buyback route entails a tax outgo of only 0.1%, which is essentially the securities transaction tax. For high dividend earners, the tax savings through a buyback are substantial. In the 2016-17 Union budget, finance minister Arun Jaitley introduced an additional tax of 10% on any dividend income of more than Rs10 lakh. Dividend distribution tax already amounts to 20.4% of payouts.
In this backdrop, it may even make sense for TCS to consider stopping the Rs9,000 crore or so of dividend payments it makes each year, and return cash through the buyback route. Of course, there are some constraints on the amount that can be returned through this route. Companies are allowed to buy back shares up to 25% of the value of their paid-up capital and free reserves, according to the Securities and Exchange Board of India. In TCS’s case, only around three out of every 100 shares held by shareholders will be accepted in the tender buyback offer, assuming most investors tender their shares. Given the premium, it’s likely most will.
To the extent possible, cash-rich companies such as TCS and Infosys should consider returning as much cash as possible through the buyback route.
TCS shares rose 4.08% to Rs2,506.50 apiece, a five-month high, on BSE on Monday.
The board meeting at which the buyback was approved is the last for N. Chandrasekaran as TCS chief executive before he takes over as chairman of parent Tata Sons Ltd, which controls 73.3% of the software developer, on Tuesday. As such, Tata Sons stands to benefit the most from the buyback.