I got a few emails to write a general post on share buy backs yesterday, so here it is – an introductory post on share buy backs.
What is a share buy-back?
A buyback offer is when a company buys some of its shares from its shareholders and extinguishes them. This is usually done from shareholders other than the promoters themselves, and is most often a testament from the management and promoters on the strength of the company, and their commitment to increase the returns for the shareholders.
Why does a company do this?
Two main reasons come to my mind.
- When a company thinks its share price is undervalued.
- Eventual delisting.
When the share price is undervalued
They do this when they think that the share price is undervalued, or when they think that this is the best way to make use of their excess cash.
If they reduce the total number of outstanding shares then the EPS (Earnings Per Share) increases because EPS is PAT (Profit After Tax) divided by total outstanding shares.
If the EPS increases then the P/E multiple decreases, and when P/E decreases, the share price increases to bring the P/E back to the higher levels. This may not always happen, but theoretically this is what they are trying to achieve with a share buyback program. Other ratios like Return on Equity and Return on Networth also improve due to this.
In fact, I think only the Debt – Equity ratio can worsen due to this because now there is less of equity to support debt, but if a company does have a lot of debt in its books then its cash is much better utilized in paying that debt off and saving interest cost rather than buying back shares from its shareholders.
Some companies, especially foreign owned companies get into buybacks because they want to eventually delist from the Indian stock exchange. Usually, they donâ€™t buy their entire outstanding shares at one go, but conduct these buybacks over a period of time and buy in tranches of 5 or 10%.
How does a company carry out a buyback?
The first step is that a buyback is proposed which is then voted on and approved by the board. Then they announce the buyback in a newspaper, announce a start date when the public can start tendering their shares, a last date of withdrawal, a close date, date of notifying when the offer is accepted or rejected, and finally the date when the shares are extinguished.
They also have to declare the price at which they will carry out the buy back and the number of shares that they will buy back.
Usually companies will only buy back a certain percentage of their outstanding shares from the public. This is really important because some people who are not familiar with how this process works end up buying shares with the hopes of a sure – fire profit, and later realize that only part of their shares will be bought back.
For example – Amrutanjan recently came out with a buy back where they said they will buy about 9 lakh shares from the market at Rs. 900. That was at a 17% premium from the day when the buy back was announced. Say in a few days the share moved up to Rs. 820, and you see it trading there knowing that the buy back is at Rs. 900. You mistake this as a risk free profit of Rs. 80 thinking that you will buy the shares and sell them back at Rs. 900 in a few days.
This won’t happen because usually there are more shares offered for a buyback than the company actually wants to buy.
In these cases they buy back the shares in the proportion of the over subscription. So you will only get a part of your shares bought back, and if the price comes down below your purchase price then you are stuck with the remaining ones. So, this is not a risk free arbitrage opportunity at all.
How do you participate in the buy back offer?
There are two types of buy back programs – one is done through purchase from the stock market, and the second one is done through a tender form.
When a company carries out buy back from the stock exchange, they just declare that they are going to buy shares from the stock market, and there is nothing that you have to do here (except perhaps hope for a gain in share price).
When the company offers to buy shares through the tender route – they will send a tender form to all its shareholders with instructions on how to fill the form and where they can mail or drop the form.
I have never done this so I don’t have any practical experience, but from what I have read you need to fill up a Delivery Instruction Slip with the trading and demat account details, attach it with the Tender Offer Form, and then drop it at one of the company’s specified collection centers.
The slip will contain the following details:
- Depository Name
- DP Name
- Beneficiary Account Number
- Beneficiary Account Name
After receiving a response from all its shareholders within the cut off date – the company will calculate how many shares it got, and in what proportion can it carry out the buy back. You will then be notified of the number of shares that are accepted and the money will either be deposited directly electronically or be sent by a check. I think how you receive the dividend is a pretty good indication of how you are going to get this money.
A share buy back means a company buying back its shares from shareholders other than promoters, they do it to increase the shares prices or Delist, and they are done by either buying in the stock market directly, or asking shareholders to tender their shares.
This is the what, why and how of a buy back, and I’ve tried to cover all aspects to the best of my knowledge.
As always, questions, comments and emails are most welcome!