With markets seeing a rollercoaster ride since the beginning of 2011, quite a few companies have offered a buyback of shares. While Zee Entertainment and pharma company FDC, were the most recent ones to do so, Reliance Infrastructure too, has been evaluating a buyback. Multinational giant, Siemens has joined the process. What does a buyback offer mean to the companys shareholder? He has been left wondering whether to participate in the buyback offer or hold back.
At times, promoters continue to remain bullish about their companys valuations, even if the market has discounted its share price. They would use its surplus cash to buyback shares from retail investors. Essentially companies retire some percentage of their total shares by doing this. Buyback is often used as a tool to instill investor confidence in the worst of times. For instance, the India Infoline share price was hammered (by close to 15 per cent in a day) when its name figured in the Money Matters Financial Services, bribe for- loans issue. However, the news about its tentative buyback offer, announced within a few weeks, sent its share price soaring by seven per cent in a day. One other reason cited for a share buyback is mainly lack of suitable investment options available to the company. So, they choose to utilise the cash in its books to invest in their own business.
PROS
The potential benefits of a share buyback programme for various categories of investors can be summarised thus: Shareholders benefit as companies offer a buyback, offer a price higher than the existing market price (see table). For the remaining shareholders, the reduced number of outstanding shares, means an increased value per share.
Speculators view it as a positive trigger for short-term trading opportunities. More often than not, shares witness good volumes and the price rallies once the buyback announcement is made; Long-term bullish shareholders benefit, as a buyback programme is an inorganic way of increasing the earnings per share (EPS), without actually increasing the companys earnings; Bearish shareholders, who are not very optimistic about the companys future, get an option to exit at a premium, if the current market price is trading at a discount to the announced buyback price.
CONS
Though share buybacks have a lot of benefits, they can be misused: Share buybacks could be announced, not because the company is undervalued, but because of vested interests. So a company that enters the markets via a public issue, may announce a buyback and delist by the time their business model has garnered a strong foothold in the industry. This deprives shareholders of any long-term benefits associated with the company.
Companies favouring Employee Stock Options (Esop) to employees have to balance investor expectations, as Esop results in further dilution of shareholder earnings. Therefore, if it is perceived that the Esop offer has not gone well with the market, the company may announce buybacks to nullify this diminishing value of earnings.
In some companies, the management compensation is linked to its EPS, so in order to strengthen the former, a buyback is announced to increase the EPS, without any quality increase in the revenue model.
Buyback programmes have potent upsides and downsides. At times, holding on to the share that has potential may be a sensible decision rather than giving up the share. Hence, each offer must be viewed independently for evaluating the value addition for the shareholder.
SIGNALS, PRICING
A buyback programme announced during falling markets certainly acts as a morale booster for shareholders. Investors, having bought the shares at higher prices, choose to hold on for making some gains in the long term. A buyback during this stage, reinforces the belief that the management remains bullish about their company. Companies usually announce share buybacks to signal to investors that the shares are worth at least the price at which they are being bought back.
History has witnessed companies, after announcing their buyback plans, realise that the economic situation getting worse and their future outlook is set to be on the wrong direction. Eventually, the companies have had to cancel their buyback plans. Such a step may be perceived as a weak signal for the company.
Summing it up, a word of caution for those shareholders who choose to not part with the equity in the buyback offer and stay on. Evaluate whether the company is paying more for its stock than its worth, even if purchasing for its own, especially in an overpriced market. Such over-pricing could definitely prove harmful for the continuing shareholders.
