Buyback, the way forward?

Are share buybacks a good opportunity to make quick money?

Companies announcing share buybacks has been on the rise in recent times. The trend has gathered momentum especially after Budget 2016-17, where the government had imposed an additional Dividend Distribution Tax (DDT). A 10 per cent DDT was announced for individuals, Hindu Unified Families or Partnership firms whose dividend income exceeds ₹10 lakh per annum.

Following this announcement, buybacks have gained traction since this is one way for companies to return capital to the shareholder. The government has extended the rule to include private trusts in Budget 2017-18.

Subsequent to the announcement of DDT, many companies in March 2016 declared dividends as there was some time before implementation. Those who missed the bus are now taking the share buyback route. In early 2016, many companies like Excel Industries, Baba Arts, ECE Industries, Smartlink Network Systems and OnMobile Global announced a share buyback. From the Nifty 50 basket, Dr Reddy’s Laboratories, Wipro and Sun Pharma had announced buybacks in 2016.

Recently, the board of Cognizant Technology Solutions approved a plan to return $3.4 billion to shareholders over the next two years through a combination of share repurchases and dividends.

Following this, investor/shareholder expectations began to rise that a host of cash-rich IT companies could consider buybacks to address shareholder concerns, given that domestic IT companies are under pressure.

TCS too recently announced that its board will consider a proposal for buyback of equity shares at its meeting to be held on Monday (February 20). TCS has ₹43,100 crore cash on its book. The stock price of the companies announcing buybacks generally gets a short-term boost. Krishan Bhanot, an active investor with Amrapali Aadya, says, “I believe the value of a company’s shares appreciate on the back of a buyback and one feels more confident when holding such shares.”

Krishan is now eager to see the price movement of TCS on its buyback announcement.

One tool, many uses

What is a share buyback? As the term suggests, a buyback is purchasing the equity shares back from the market.

It is an alternative mode of reduction in capital without requiring approval of the Court/CLB(NCLT). By doing so, a company reduces the number of its shares on the open market, thereby allowing the firm to invest in itself.

One major reason for share buyback is to bring down the public shareholding and, in turn, increase the promoters’ holding.

It is also one of the ways to use the company’s cash reserves rather than giving it as a dividend and increase its earnings per share (EPS), return on capital and the return on net worth. Also, if the company has any plans to delist, it can opt for share buyback. For investors it provides an additional exit route at times when the shares are undervalued or thinly traded during periods of sluggish market condition. Further, buyback helps to prevent unwelcome takeover bids.

At times it is also used as a tool to arrest the fall in stock prices. For instance, following a steep fall in share price in 2015, Dr Reddy’s announced its buyback plan in 2016 in order to arrest further fall in its stock price.

Traders can use buyback announcements to take trade positions as well. Narayanan Venkataraman, Chief Operating Officer at CVIAC Consulting, who has about three decades of work experience in the IT sector, started tracking Hexaware Technologies following its buyback announcement. He says, “Hexaware Technologies was trading at good levels. The buyback news gave me confidence to trade in this stock and it yielded good returns in a short span of time. I still have some shares and am planning to exit at higher levels.”

Good buying opportunity

How does share buyback happen?

Buybacks can be carried out in two ways. One is by giving shareholders an option to give back a portion or all of their shares within a certain time frame at a price premium to that of the current market price. This premium compensates investors for tendering their shares rather than holding on to them.

Chennai-based value investor Ravi Padmanabhan bought Balrampur Chini after the company had announced a buyback as he felt the company had strong fundamentals.

He had exited the shares of Eclerx prior to buyback announcement in 2016. He feels that buyback is advantageous for small investors for whom 15 per cent is reserved. He says the acceptance ratio is high for small investors. “Usually the acceptance ratio will be known only once the entire process is over. If this ratio is low, then one can see the stock prices weakening,” says Ravi, who has been investing for the past 15 years.

The second method by which companies buy back shares is from the open market over an extended period of time. Kiran, an active trader from Epic Research, says “I stayed invested in Maharashtra Seamless for almost half a year during its buyback program. I was quick enough to make a healthy profit of 25 per cent on invested capital.”

Indiabulls Real Estate and GHCL have announced buybacks from the open market through the electronic trading mechanism of the Exchange. The buyback price would not exceed ₹90 per equity share payable in cash for an aggregate amount not exceeding ₹540 crore for Indiabulls Real Estate.

The stock currently trades at around ₹75. The company has six months from the date of the opening of the buyback. For GHCL, the maximum buyback price would not exceed ₹315 per equity share payable in cash for an aggregate amount not exceeding ₹80 crore. This stock is quoting at around ₹266.

Last October, Sun Pharma said that it had completed share buyback worth ₹675 crore to return surplus funds to its shareholders. The maximum buyback price was ₹900 per share for an aggregate amount of ₹675 crore.

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