The two types of share buybacks

by Manshu on August 31, 2011

in Investments

In my post about introduction to share buy backs I touched upon the two types of share buybacks that can take place in the Indian share market, and a recent comment by Raja52 about the buyback offer of Allied Digital and their share price presents a a good practical example of one type of share buyback that you should be particularly mindful of.

 

As I said earlier, a company can buy back its shares in two ways:

  1. They can buy the shares from the stock market.
  2. They can buy the shares from the shareholders by asking them to tender their shares.

It is important to know what route the company is going to follow. If they are going to buy the shares from the stock market, then the share buy back price is of little meaning to you.

Raja brought up the example of Allied Digital Services Limited. Their buy back price is Rs. 140, and the current market price of the share is just around Rs. 33!

Is that a great opportunity or what?

Not because of the share buyback  – it isn’t.

Allied Digital is going to buy the shares from the stock market and not from the shareholders, and the price of Rs. 140 is not actually the buy back price, but it’s the maximum price at which they can buy back their shares. When companies get approval from their boards to buy back their shares from the stock market, they have to set a maximum price. This is the upper limit beyond which the company can’t buy their shares from the share market.

So, if Allied Digital has set up a maximum price of Rs. 140 – it only means that they can’t buy shares at a price over Rs. 140. They can buy the shares at any price below Rs. 140, and can certainly buy it at the Rs. 33 or so at which it’s currently trading.

As far as retail investors buying the shares at 33, and selling it to Allied Digital 140 is concerned – it’s not going to happen, and in a way – the low price already tells you that. Had it been the buyback where the company had promised to buy its shares back from the investors directly – the 140 number had more importance, and they would have probably not even chosen such a high number.

Lesson: Find out if the company is buying shares from the public or from the share market, and if they are buying from the share market then ignore the buy back price because it’s really the maximum buyback price.

If the company is buying back from the shareholders then you have to look at how many shares they have offered to buy, how much time is left for the buyback to take place, and what is the difference between the current market price, and the offer price.

What decision you take depends on these variables, and they can be so different in every case that you will have to evaluate each offer on its own merit.

In general, I’d say don’t buy shares in companies you wouldn’t otherwise mind owning. ABB is a good example that comes to mind – they are a solid company that came up with a buy back offer last year, and the good thing about that is even if your shares don’t get accepted in the buy back you still own a very strong company with good prospects.

Other than that, I don’t think you can make generalizations and will have to evaluate each offer on its merit.

{ 2 comments… read them below or add one }

VINOD ARORA September 1, 2011 at 2:00 AM

No generalisation….well said!!

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Shirish April 11, 2012 at 10:56 AM

Don’t get misled by buyback price, especially of Indian companies. It is the maximum price and usually the company never buys the share at maximum price. Max buyback price is usually way above the market price and is meant to mislead the investors by taking advantage of some loopholes in deciding the buyback price. For multinationals companies, the purpose of buyback is usually to delist the shares and in such cases, the market price climbs up close to the buyback price announced by the company (examples: atlas capco, Alfa Laval etc). For indian companies, the buyback is supposedly to increase shareholder value (reducing equity of the company) by using excess cash which can’t otherwise be deployed gainfully. Recent example is Reliance. Buyback price (max) is 870 and the market price is hovering around 750. Reliance announced buyback to mask their very poor performance in last few quarters, Allied digital did that as the stock price was beaten black and blue in the markets due to IT raid and promoters with dubious credentials. There are many other similar cases.
Bye and take care

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