A Buyback is a word which is trending on the Dalal Street at this moment. Why? The simple reason is that a couple of Indian companies, namely Wipro and others have announced to repurchase (share buyback) its own shares from the market just a few days back.
The Wipro board on April 16 approved a buyback for up to 32.3 crore shares at INR 325 per share totalling up to INR 10,500 Cr. The Company’s board has approved a proposal to buy back up to 32,30,76,923 equity shares being 5.35% of the total paid-up equity share capital.
As per SEBI rules, a company can repurchase its shares just once in a year.
A company isn’t permitted to make any idea of buyback inside a time of one year figured from the date of expiry of buyback time of the former buyback offer assuming any, according to rules.
In the past few years, IT majors namely Tata Consultancy Services (TCS), HCL Technologies, Cognizant Technology Solutions, and Mindtree have all announced share buybacks.
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So, the question here is what is share buyback? And why do companies go for share buyback? Let’s check this –
What Is A Share Buyback?
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There is no definition given by the Company Act, 1956 about the buyback of shares. But in simple words, a buyback share means repurchase of its own shares by the company. In other words, a buyback of share means a Company buying its own shares.
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A buyback is exactly reverse of the issue of new shares by a company where it offers to take back its shares owned by the investors at a predetermined price; this offer can be mandatory or optional to the investors.
Company Can Buyback Shares in 2 Ways
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Open Market Purchase: In this case the company buys share from the open market up to a maximum price fixed by it. Promoters are generally not allowed to participate in this buyback.
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Open Tender Offer: All shareholders (including promoters) are allowed to take part in this type of buyback. Shareholders have the choice of submitting the shares back to the company during the buyback period at the price fixed by the company.
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Why Do Companies Buyback Shares?
Companies typically have two uses for profits.
Firstly, some part of the profits can be distributed to shareholders in the form of (1) dividends and (2) stock repurchases.
The remaining amount, known as retained earnings, are kept with the company itself and used for investing purpose in the future of the company if profitable schemes for reinvestment of retained earnings can be identified.
1) To Increase Promoters Shareholding
When a company buys back its own shares, it reduces the number of shares held by the general public and at the same time increases promoters holding in the company. The reduction of the publicly traded shares also means that even if the profits of the company remain the same, the earnings per share (EPS) increase. So it’s like a dual advantage.
2) To Take Advantage of Undervaluation
Apart from disbursing free cash flow, share buyback may also be used to signal or/and take advantage of undervaluation.
If a company’s management believes that their firm’s share is currently trading below its fundamental value, they may think about share repurchases – an open market buyback, whereby no premium is paid over current market value, offers a possibly profitable investment for the company manager.
By doing this, they repurchase the currently undervalued shares of the company, wait for the market to turn to the undervaluation whereby prices escalation to the fundamental value of the equity, and re-issue them at a profit.
3) To Prevent Takeover
Share buyback evades the accumulation of excessive amounts of cash in the company.
Companies with strong cash flow generation and minimal capital expenditure will tend to generate more cash on the balance sheet, which makes the company an attractive target for a takeover since the money can be utilized to square off the obligation brought about to carry out the acquisition.
Hostile-takeover policies, therefore, often includes keeping a thin cash position and share buyback boost the stock price, making a takeover more expensive.
4) To Pump Up The Stock Price
At times when the company feels that its shares are currently undervalued, a share buyback offer is used to inflate the stock price, which acts like a support for the stock.
There could be an end number of reasons why share prices of a particular company are trading lower despite solid fundamentals.
A buyback, on the other hand, reassures investors that the company has confidence in itself and is dedicated working towards creating value for its shareholders.
5) To Take Tax Advantage
Share buyback allows companies to distribute their earnings to the investors without inflicting them with taxation.
6) To Reward Its Shareholders
Another common reason for companies to go for a share buyback is to distribute surplus cash to its shareholders because the proposed offer is usually more than the current price.
This is normal practice when the share prices of the company keep falling and there is absolute nervousness among the shareholders either about the sector as a whole or the business itself.
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Share Buyback Benefits to Retail Investor
Retail investors can use the share buy back opportunity to tender their shares which may be trading at a value lower than the offer price. The more shares accepted by the company at the offer price, the higher the benefit for the shareholder.
When companies announce results (profits), they track their progress in part by looking at earnings per share. With fewer shares trading, the EPS number usually rises. This can help the company beat market expectations for their performance and help drive a higher stock price.
When a company buys back share, investors usually see it as a sign the company believes the price should be higher, that investors are not realizing the company’s true value. This can sometimes kick off an upward swing in stock price.
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