Share buyback by listed companies is not new in India, but the pace at which it’s been expanding since 2016 is definitely making headlines. Quite a few companies in India are investing a substantial amount of idle capital in buying back or repurchasing their shares. Most recently, India’s bellwether information technology company Infosys, which is incidentally in the eye of a storm over its CEO’s resignation following a spat with the founders, has just announced a massive Rs 13,000 crore buyback at Rs 1,150 per share — a hefty premium to the market price.
Since 2015, some of the prominent names involved in share buybacks include TCS, Reliance Industries, Infosys, Coal India, Cognizant, Novartis India, Wipro, NMDC and National Aluminium, of which some of them comprised of promoters increasing their stake.
There are a number of reasons for a listed company to initiate a share buyback:
- The company could have excess cash in its balance sheet but may not have a suitable alternate investment option;
- As a confidence building measure to arrest fall in prices;
- Reduce market cap, thereby improving the issuer’s earnings per share (EPS);
- Lower dividend pay-out to shareholders thereby resulting in lower taxes at the hands of the company;
- Higher return on equity (ROE) leading to higher valuations;
- In preparation of a large order that could lead to a spike in share prices;
- If the shares are undervalued; or
- To prevent or deter hostile takeovers.
According to buy-back norms laid out by SEBI, there are two ways in which a listed company can go about repurchasing its shares from existing shareholders, namely:
- Open market purchase: If a company opts to buy shares from the open market, it makes an offer to shareholders indicating the max price and the number of shares it wishes to purchase. However, the company is at liberty to pay less than the initially offered price and is not obligated to purchase the entire quantity as announced in the repurchase plan. Only public shareholders are permitted to participate in the open market buyback.
- Tender route: Here the company directly purchases shares from the shareholders on a proportionate basis. The biggest plus is the company fixes the price at which it intends to buy the shares, which are generally higher than the market prices, thereby benefiting shareholders. Both promoters as well as public shareholders participate in the process.
In financial year 2016-17 alone, there were more than 40 listed companies announcing share buybacks to the tune of 30,000 crores, making it the highest ever in terms of value in a single financial year in the history of the Indian equity markets. The last four financial years prior to this one saw about 80 buyback offerings with the total value amounting to about 28, 000 crores.
So why this sudden rush in 2016-17? The answer could probably lie in the 2016-17 Union Budget. Generally, companies paying dividends are liable to pay a dividend distribution tax (DDT) to the Government at 17.647 percent, in addition to surcharge and cess. On the other hand, shareholders receiving dividends were exempt from paying any additional taxes.
However, with the amendment of the Finance Act 2016, individuals, HUF’s and partnership firms whose dividend income exceeded 10 lakhs in a financial year were added into the DDT tax bracket with their tax liability at 10 percent of the dividend value. The list included private trusts in the 2017-18 budget. According to the Income Tax Act, share buyback would not attract dividend distribution tax if it is within the provisions of the Companies Act, thereby allowing companies to save crores of rupees in taxes.
As for a current offer which presumably will have a lot of investor interest, Infosys’s massive Rs13,000 crore buyback, amounting to nearly 5% of the company’s share capital, has barely moved the needle as far as sentiment for its shares goes. The company’s shares fell over 5% on Monday, taking the total fall in the company’s market capitalisation to as much as $5.3 billion since Vishal Sikka quit his position as chief executive officer last Friday.
Infosys stock is riddled with issues outside the buyback, not having a strong management at the helm is something Infy has struggled with for the better part of this decade. This uncertainty going ahead could cause further stress on the stock price.
While there is no clear data to suggest the impact of share prices post buyback, in a majority of cases, the shares have rallied although there are instances when the prices of the company’s shares have fallen during the buyback offer. A typical example is Coal India whose shares dropped more than 4 percent between 3 October-18 October 2016, when the company offered a Rs 3650 crores buyback via the tender route.
Taking a broader fundamental view, share buyback should generally lead to rise in prices at least in the near term due to a rise in the company’s EPS as a result of the buyback. However, in the long- run all the other fundamentals come into play which will determine the overall trend.
For shareholders, exiting during a buyback could prove to be extremely beneficial as they would receive a premium to the current market price and especially if the broader market trend is not very encouraging.
Nikhil Kamath is co-founder and head of trading at Zerodha.