Fiscal 2017 has been in the news for buyback announcements made by companies. So far this year, about 50 companies have announced buybacks, amounting to over ₹51,000 crore.
TCS’ ₹16,000-crore buyback, the biggest India Inc has seen so far, is one of the latest additions to the list.
More companies, too, may join the bandwagon. Here’s the low-down on buybacks and how investors can evaluate the same.
What’s a buyback?
A buyback is a scheme by which a company repurchases a certain amount of its outstanding shares. Once taken back, these shares are extinguished by the company.
Typically, companies that have excess cash in their kitty, with no specific investment or other deployment requirements for the same, may consider buybacks. Reducing the number of shares in this case helps in improving the earnings per share for continuing shareholders and perks up the return on equity.
Buyback of share from the public can also be done if promoters want to hike their stake in the company, sometimes to avoid any takeover threats.
Buybacks can be done either through the tender offer route or through open market purchases. In the former, the company fixes a buyback price and accepts shares on a proportionate basis during the buyback period.
Shareholders will be sent a letter of offer; a form is to be filled in with the necessary details and sent back to the company accompanied by the required documents. Promoters are allowed to tender their shares in this route.
Under open market purchases, the company specifies a maximum price and buys back shares from the market during a defined time period. Promoters cannot take part in this route.
The decision of a shareholder to participate in a buyback is based on a number of variables specific to the stock — such as the buyback price, the number of shares that can be sold and the prospects for a company. Investors need to take note of three factors before they take the plunge.
Acceptance ratio
When a buyback (tender offer) is announced at what you think is an attractive price to exit the stock or book some profits, the ‘acceptance ratio’ plays a role in deciding how much of your holdings you can actually sell.
With ₹16,000 crore, TCS is proposing to buy back 5.61 crore shares at ₹2,850 per share (market price of ₹2,506 as on date of announcement) on a proportionate basis.
This accounts for roughly 10 per cent of the 52.55 crore shares held by the public, implying that only about 10 in every 100 shares could possibly be accepted under the buyback scheme from the public.
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.
SEBI (the Securities and Exchange Board of India) has mandated a reservation of 15 per cent of the buyback offer for retail investors with holding of up to ₹2 lakh (market value as on record date).
Coal India, for instance, came out with a tender offer to buy back 10.89 crore shares for ₹3,650 crore during October 2016.
This accounted for about 8.5 per cent of the total public holding of 128.53 crore shares, implying that only about eight in every 100 shares could possibly be accepted.
But thanks to the reservation of 1.63 crore shares for small shareholders, the company offered to buy back 5 shares out of every 22 shares ( i.e. about 23 shares for every 100 shares) from them.
For other general shareholders, 5 Equity Shares for every 337 Equity Shares was the buyback ratio ( i.e. approximately 1.5 shares for every 100 shares).
But in the end, only 28.5 lakh small investor shares ended up being tendered in the buyback and hence, all that was tendered in this category was accepted.
Bottomline: Acceptance remains a bit of a wild card factor. But if you fall within the definition of a small shareholder and find the buyback price attractive enough to tender, you may not get a raw deal after all.
Open market nuances
When companies decide to take the open market route to buyback, investors need to take into account a few things.
One, 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.
Take ADF Foods, a small-cap stock whose open market purchase was on during August 10-November 15, 2016.
The company proposed to use ₹18 crore for buying back shares at a maximum of ₹125.
The stock price crossed the maximum buyback price in August 2016 itself and has remained higher ever since. As a result, the company only used ₹9.63 crore (53.5 per cent) out of the intended ₹18 crore for the buyback.
In such cases, where share prices continue to remain higher than the maximum buyback price after the closure of buyback, it could make sense for shareholders to sell even after the buyback period.
But take the case of Dr. Reddy’s Labs. On the date of announcement of the buyback at ₹3,500 in mid-February 2016, the actual stock price was ₹2,961.
With the buyback period set between April 18, 2016 and June 28, 2016, the stock price moved steadily up to cross ₹3,500 by early July 2016.
But the stock has been on the decline ever since, now trading at around ₹2,700. Investors who did not make use of the opportunity to sell the shares when the buyback window was open may be a harried lot today.
Bottomline: 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.
Signal from buyback
Since the buyback price is usually set at a premium to the prevailing market price, a buyback announcement sends out a positive signal for the stock. Ideally, it denotes undervaluation of the stock and the management’s confidence in the company’s prospects.
But in some cases, buyback becomes a tool to help keep the stock prices high, especially in volatile markets or when the company is faced with some headwinds. This is one of the reasons why buyback stocks tend to lose sheen over the medium to long term. (eg. Dr Reddy’s, Cairn India).
It is very rare that stock prices, over the long term, have remained above the buyback price. Hindustan Unilever (HUL) is a good example of this.
The company saw two buybacks to the extent of ₹630 crore each at prices of ₹230 and ₹280 in 2007-08 and 2010-11. Ever since, the stock has not returned to these levels.
It has steadily climbed up to about ₹900 now. The stock has also seen a re-rating from the 20-30 times it used to trade about 6-7 years ago.
Bottomline: If you are a really long-term investor holding a stock with solid fundamentals, ignoring buyback offers may be the best way to retain multi-baggers.