29 Aug 2017 22:03 IST

The nitty gritty of share buyback

In buying back shares, a company plans to use up surplus cash or stoke the value of its stock price

If you are holding shares of Infosys, you will want to know whether to tender the shares in the buyback or hold them. But first you need to understand what buybacks are and what factors you need to consider before deciding whether or not to tender your shares in the offer.

Buybacks are one of the ways in which companies reward their shareholders. In the process, idle cash in the coffers is paid to investors who are willing to sell the shares back to the company. This reduces the outstanding shares of the company and, as a result, the earnings per share goes up. The shares that are bought back are extinguished.

Impact on stock price

If the number of shares bought back through the offer is large and the EPS scales up, it will have an impact on the stock price, and the valuation will become more attractive, with higher EPS making the stock price move higher. And, given that after the board approves the buyback, it has to get the shareholders’ approval, which is done through a postal ballot process, it takes time for the company to announce the record date.

So, if the buyback is announced at a good premium to market price, the stock rallies from the date of announcement of the buyback till the record date as traders, exploiting the arbitrage opportunity, buy the stock. Wipro’s buyback is a case in point. The company announced its buyback on July 20, at a near 24 per cent premium to the market price. The stock has seen the price rally sharply since then — from ₹269 on July 20, to about ₹290 now.

Two routes

Buybacks are generally done either through the tender offer route or open market purchase.

In open market purchase, the company specifies a maximum price and buys shares from the market through the bourses at that price.

In the tender offer, the company announces a buyback price and makes the open offer to all shareholders including the promoters. Given the number of shares the company is willing to buy back, the shares tendered by the shareholders are accepted on a proportionate basis. What protects the interests of the small shareholders is the reservation of 15 per cent in the buyback. As per SEBI’s buyback regulations, there is a reservation for small shareholders to the extent of 15 per cent of the number of equity shares which the company proposes to buy back. A ‘small shareholder’ is defined as one who holds equity shares having market value on the record date of not more than ₹2 lakh.

How much money an individual retail shareholder can make in the buyback depends on how many shares he can actually sell in the buyback. This ratio of number of shares that will be accepted vis-à-vis what investors tender in the offer, is called the acceptance ratio.

Infosys buyback

In the Infosys buyback, the acceptance ratio, works out to 60 per cent. Here’s how: As on March 31, Infosys had about 6.27 lakh shareholders whose combined holdings were worth ₹2 lakh or less — and this was through holdings of 2.87 crore shares. Of the total buyback of 11.3 crore shares announced by the company, the 15 per cent reservation for small shareholders comes to 1.69 crore shares.

Now, if we assume that, as on the record date too, there is almost the same number of shares that qualify for the reservation, then the acceptance ratio, assuming all those shares are tendered in the offer, is 1.69 divided by 2.87, which is 59 per cent.

But, given that the record date is not yet announced, and as on that date, the number of small shareholders and the shares they hold could be even higher, there is a risk of the acceptance ratio going down.

In the TCS and HCL Technologies case, however, the final acceptance ratio was better.

In the TCS buyback, for instance, the acceptance ratio originally appeared to be about 45 per cent for small shareholders. The company had 1.87 crore small shareholders as of the record date and the reservation in the buyback for them was 84.21 lakh shares. But, during the buyback, only 41.97 lakh small shareholders actually tendered their shares and, hence, all of it was accepted.

What you should consider

A company’s buyback is an indication of two key things — one, the company is not able to find a better way to use its cash; and, two, it wants to stoke the value of its stock price.

So, when growth is expected to stagnate due to the lack of plans for future acquisition or re-investment in the business, you need to first consider if you want to continue to hold the stock. In a scenario like this, if the buyback is at a good price and at a premium to the market price, then you can go for it.

Traders have to keep in mind that there will be short-term capital gains of 15 per cent, and the profit will reduce to that extent.

Also, note that if you want to tender shares in the buyback, your name should be in the register of the company as a shareholder on the record date. It takes two days for the stock to come to the demat account from the date you purchase, so ensure that there are at least three-four working days from the day you purchase the stock till the record date.

After the date of closure of the buyback, it can take seven to eight days for the final declaration of accepted shares. So, you cannot sell your shares immediately, even if the market price goes up. So, before tendering your shares in the buyback, you need to assess if you have the capacity to hold the stock for a week or so before you can book profits to take back the profit.

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