When an entity makes an offer to shareholders of a listed company for purchasing their shares at a particular price and within a specified timeframe, it is known as open offer. The offer could be either voluntary or mandatory. An investor crossing the thresholds of 15%, 55% or 75% holding in a listed company has to come out with an open offer for at least 20% more equity, according to Sebi's 'Substantial Acquisitions and Takeover Code'.
Share Buyback
A stock buyback, also known as a 'share repurchase', is a company buying back its shares from its shareholders. The repurchased shares are cancelled, thereby bringing down the number of outstanding shares. As a result, value of each remaining share goes up, thanks to higher per share earnings. Shareholders not participating in buyback also see their stake in the company's ownership rising post buyback. A company buying back its shares is generally viewed as a positive thing.
Typically, buybacks are carried out in one of two ways:
(A) Tender offer
The company will send an offer to its shareholders to sell all or a portion of their shares within a stipulated time frame and the offer price. The company could be out to buy only a part or all of its outstanding shares and delist itself. In the case the company is planning to delist its shares under the reverse book-building method, only the floor
(B) Open market
price is given. The company can also buyback its shares from the open market, just like any other investor. It has to announce its intent of the buyback, the duration, maximum price and the total amount that it will utilise for this purpose. Such offers can remain open for a long period of time or until the amount earmarked by the company's is fully utilized.
Why is this done?
To support the share price: An overall weak market outlook can bring down the stock price substantially. In such a scenario, a management may decide to support the share price with a buyback to boost investor confidence. For example, after its three buyback programmes during FY09 and FY10
To fight the impact of equity dilution: A share buyback reduces the number of shares in circulation and hence is a great measure to fight equity dilution caused by events such as employee stock ownership plans (ESOPs) or bond conversion.
Increase promoters' stake: A buyback offer could be unveiled with a view to enable the promoter group to increase their stake in the company. Since the shares bought back are extinguished, those who are not participating in the offer will see their stake in the company's overall equity going up.
The Price Detector
When it comes to open offers, the Sebi has issued guidelines to determine the minimum price at which the open offer can be made. However, there is no upper limit. According to the Sebi rules, the highest between the average prices of the past 26 weeks and the past two weeks should be considered as the minimum price for an open offer.
Buybacks are generally voluntary on the part of the company and, hence, there is no mandate on its minimum or maximum price. However, only when the company plans to delist its shares, a 'floor price' has to be discovered in line with the Sebi's guidelines.
A reverse book-building process follows where retail shareholders can tender shares at any price higher than the floor price. The price at which maximum number of equity shares are tendered becomes the 'Discovered Price'.
However, when it comes to how high an open offer or buyback price should go, it is the acquirer's need and financial ability that play a key role.
The Action Plan
An open offer or a buyback can be an exciting but temporary opportunity to make profit for investors. However, investors need to take an informed decision based on the intentions of the acquirer, the offer price and the company's future prospects.
At the same time, keep in mind the fact that once the window of opportunity closes, the share price is likely to go back to its pre-offer levels.
It is, therefore, important for investors to carry out a fundamental research on the company to identify its current fair value and expected fair value a year down the line. If the fair value in near future is likely to cross the offer price, one should hold onto his investments. It shouldn't, therefore, come as a surprise that in four out of six open offers, which are currently on.
Another alternative for investors is to sell in the open market when the stock prices surge on news. An avid investor can actually fare much better by selling out in the market before the offer closes and covering back once the prices fall after the offer closes.
A Pitfall To Avoid
Investors must resist temptation to play the arbitrage game by buying in the open market after an open offer announcement and selling in the offer. This is risky since investors may get stuck up with a portion of their holdings, which will be worth much less in the market post-offer.
Even after an open offer is announced, the market price of the scrip tends to remain somewhat below the offer price, which one may regard as arbitrage opportunity. However, since the offer is for a limited number of shares, after the offer closes investors are likely to find themselves with a portion of their holding not accepted by the acquirer. If the market price crashes post-offer, the gains made in the offer are likely to get diluted or even negated.
The special opportunities offered by the 'open offers' and 'buybacks' are too attractive to miss. Investors need to do their homework, resist the temptation to trade and try to estimate how things will pan out a year later to take the best call. Often, holding onto his investment, rather than taking a quick exit, could turn out to be the best strategy for an investor.
BUYBACK
• DONE BY the company itself
• GENERALLY, the number of shares reduce after a buyback
• BUYBACK can be through open market operations or through the tender route
• BUYBACKS, are voluntary on the part of the company
• THERE is a maximum limit or ceiling up to which a company can raise its equity through buybacks during a year
OPEN OFFER
• DONE BY promoters or any other third party other than the company
• OPEN OFFERS, don't result in change in the number of outstanding shares
• OPEN OFFERS are typically through the tender route only
• IN MOST instances, open offers are mandatory rather than voluntary
• THERE is a minimum limit of 20% with no maximum limit in case of open offers
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