RECENTLY MANY COMPANIES across sectors such as information technology, pharma,cement,sugar,textiles,engineering made buyback offers to their shareholders and this trend is expected to continue.Let us understand what are buyback offers, why companies go for buyback and how should a shareholder evaluate the same. Buyback offers Acompanybuys back its own shares generally at a price higher than the prevailing market price. Companies buyback their shares eitherthrough open tenderofferorin the open market. Under open tender offer shareholders including promoters can submit either a part of their holding or full within a certain time window to the company at a price determined by the company. Companies can
Under open tender offer shareholders including promoters can submit either a part of their holding or full within a certain time window to the company at a price determined by the company. Companies can buyback their shares from the open market over a specific (normally extended) time period. The shares bought back by the company are cancelled and shown as ‘treasury stock’ in the balance sheet.
Companies tend to go for buyback offers when they have significant amount of surplus cash and no lucrative projects to invest, lower growth prospects,no plan for acquisition, expansion,diversification,etc.Further, companies also felt that the current share price is cheaper to buy.
A buyback announcement sends out a positive signal for the share. Companies offervarious reasons forbuyback such as to attain optimum capital structure, to improve earnings per share, to prevent unwanted takeover bids, to service the equity more efficiently, etc.
Since July 2015, buyback offers are taking place through the stock exchanges and security transaction taxes are being paid on such transactions. Owing to this, long-term capital gains made are tax-free and shortterm gains are subject to a tax of 15%.
Further, large shareholders (who earn above `10 lakh through dividends) are being taxed at 10% tax, thus buybacks are more tax-efficient way than that of dividend not only for large shareholders but also promoters who holds a controlling stake in their company. For buyback offer, Securities and Exchange Board of India (Sebi) has also mandated 15% reservation for retail investors holding shares whose market value as on record date is up to `2 lakh.
Look at the outstanding debt Sometime, companies may go for buyback inspite of having significant amount of debt in its balance sheet. In such a scenario, investors should evaluate why the company is announcing buyback instead of paying back its debt.
Open market or tender offer
How the buybacks are offered—whether through open market or tender offer—is an important point to consider.Promoters are not permitted to participate in the open market method whereas the tender offer method is open to them. If promoters are participating in buyback, it is likely to be positive for shareholders in the long run.
Look at the offer price
Before selling your shares under buyback, consider carefully the offer price being made.As a shareholder,you are going to gain only if buyback offer price is significantly higher than the current market price and the quantum of the buyback amount is substantial.
Another relevant point is how the buyback is being financed: is it through internal resources or through external debt? If the company takes an external debt and goes for buyback one needs to re-look at the capital structure of the company and other relevant points.
It is difficult to take a decision on whether to sell shares in a buyback offer. It is a function of your expected rate of return and your holding period. If you are really a long-term investor with an investment horizon of 10 to 15 years, ignore the buyback offers so that your share can be a multi-bagger.
The writer is associate professor of finance & accounting,IIM Shillong