Buyback of shares- Is it good or bad?

Buyback of Shares

Buyback of shares is a corporate action in which a company repurchases or buys back its shares from the existing shareholders.  The buyback is done at a price that is usually higher than the current market price. Buyback is issued by companies that have an extra surplus or has an excellent cash flow statement.

The Company will announce the size of buyback and will set a maximum buyback price per equity share. For example, on Apr 2021, Infosys board of directors approved Rs 9200 crore buyback of shares at Rs 1,750 per share. Any shareholders can return shares in the buyback. The period of buyback, price and quantity of shares decided beforehand. It is essential to have cash with the Company.

Why do companies bring buyback of shares?

The Company brings buyback for the following reasons:

• The Company have excess cash in its balance sheet and is unable to utilise the money.
• The Company does not need funds for further expansion.
• The Company is still having money left after paying the dividends.
• The outstanding shares of the Company in the market get reduced.
• The promoter’s holding in the Company increases.
• Buyback is more beneficial than giving dividends as it is taxed in the hands of shareholders.
• When companies announce buyback, the shares of that companies are more bought by which they support the undervalued shares.

Benefits of buyback of shares for the Company

Buyback is more beneficial for the Company for the following reasons:

• Buyback of shares helps in improving a company’s valuation.
• The companies do not incur tax on buyback.
• Buyback of shares reduces the supply of shares in the market, which in turn increases the stock price.
• Buyback of shares improves the financial ratios, like ROE and EPS.
• The P/E ratio is also improved.
• The buyback also strengthens balance sheets.

Benefits of buyback of shares to the investors

Buyback is the way of giving additional cash to the shareholders.

• Buyback of shares is done at a premium that is higher than the current market price.
• The shareholders get a chance to sell their shares at a high price.

Types of buyback

There are two types of buyback- Tender offer and Open market offer.

Tender offer

In this offer, the shareholders get a communication from the Company through email or speed post that the Company is interested in buying shares from them. Those shareholders who want to benefit from buyback can fill the offer letter and send it to the company registrar or participate online through their brokers. 

After such communication, the Company announces a book closure date during which you have to offer (or tender) the shares to the Company within the given time frame.

The buyback price, duration of the offer, the number of shares sought by the Company is decided beforehand.

The shareholders like the tender offer because they can earn decent returns by offering their shares at a premium.

Open Market offer

In this offer, the Company does not send any communication to the shareholders. The Company buys shares directly from the secondary market and implements the buyback program. By the time buyback opens every month, the Company announces how many shares they have purchased and how much equity capital has been made.

The maximum price of the buyback is fixed. Up to this price, the Company can buy shares at any time. Buyback is not possible above the maximum price set. The buyback of shares generally happens over a longer period as many shares have to be brought. Unlike tender offer, it does not impose any legal obligations on a company to complete the buyback program. Thus, a company enjoys the flexibility to cancel the buyback program at any time.

Open market offers are more beneficial for the Company because of their cost-effectiveness. The company buyback its shares at the current market price and doesn’t need to pay a premium. Tender offers are beneficial for investors.

How does buyback of shares come?

The Board’s approval is required to bring the buyback. It isn’t easy to bring buyback without the consent of the Board. The buyback also needs the approval of the shareholders and the market regulator, i.e., SEBI and the Stock exchange.

What will the regulator see?

• Promoters are not raising share prices without reason.
• The Company’s financial condition before the buyback.
• The Company should have enough cash for the buyback.
• How much debt and equity are on the Company?
• Promoters will not overturn by announcing buyback. Elsewhere investors were not misled.
• The regulator will see the consolidated balance sheet.

After all these approvals, the Company will announce the record date and the period of buyback.

Record date– The fixed date on which you should have shares in your Demat account. If there are shares in your account, you will be able to offer shares in the buyback.

Ex-date– You have to buy shares before this day. Buy shares before ex-date to participate in the buyback.

Period of buyback– The Company reports the opening and closing dates of the buyback. You have to tender or submit the shares before the buyback is over.

Who can participate in buyback?

All shareholders can take part in the buyback. The only thing required is that you should have shares in your Demat account on the record date. Mutual funds, banks, insurance companies, FIIs and Promoters can also participate.

Categories of investors in the buyback

There are two categories of investors, i.e., retail and non-retail.

Individual investors holding Rs 2 lakhs in their Demat account as on the record date qualified under the retail category. 15% quota reserved for the retail investors.

Assume you have Rs 2,00,000 worth of shares in your Demat account, and the buyback price is
Rs 2100. Then, you can apply for Rs 2,00,000/2100= the number of shares.

Institutional investors like MFs, DIIs, FIIs and promoters come under the non-retail category. 85% quota reserved for the non-retail investors.

Acceptance ratio

The acceptance ratio defines how many shares will be approved out of the total applications. The ratio will be better if the promoters do not participate.

Assume a company announces Rs 150 crore buyback and shareholders offered Rs 1000 crore of shares. In this case, the Company will not accept all shares of every shareholder. The Company accept shares as per the acceptance ratio by looking at the overall demand and supply.  The Company will tell how many shares of each shareholder were approved in the buyback. The shares that have not been accepted will be returned to your account.

Does buyback even cancel?

The Company can cancel the buyback. It has the freedom to cancel buyback. The buyback will also be cancelled if there is no consensus in the board meeting. If the shareholders did not approve the buyback and if the market regulator, i.e., SEBI, found something wrong, it would be cancelled.

The cancellation of buyback will negatively impact the share price because it harms the investors’ sentiments.

Conclusion

Companies with strong fundamentals bring buyback. It allows the investors to earn by taking less risk. But investors should focus on the companies offering the buyback, understand the acceptance ratio correctly, and estimate the share price after the buyback. The higher the price, size or quantity of buyback, the better it is for the investors.