The last few years have witnessed a surge in companies going for buy back of shares and the trend seems to be accelerating this year. A Buyback of Shares occurs when a company buys some portion of its shares from its shareholders. This Buyback from the shareholders is usually at a price higher than market price. The shares bought back are many times extinguished and as a result the number of shares of the company outstanding in the market reduces. Thus while the company in one way rewards its shareholders by buying a portion of their shares at a premium to market price, the company’s return ratio also improve due to reduced Share Capital. The company buying its shares at rate higher than the prevailing market rate also opens up an arbitrage opportunity for some short time investors and traders. However these opportunities are not always a profitable proposition and can backfire too and the end result in buyback of shares is influenced by many other factors as well .
Types of Buyback
The two most popular type of Buybacks used by companies are:
1) Buyback through Tender Route: Shareholders are presented with a tender offer where the entitlement for buyback is on proportionate basis to one’s shareholding. There is a separate quota (15%) reserved for Retail investors i.e. those whose shareholding at market prices is less than Rs. 2 Lacs. The Shareholders have the option to submit (or tender) a portion or all of their shares within a certain time frame and at already declared Buy back price which is normally fixed at premium to the current market price of the company. This premium provides incentive to investors for tendering their shares rather than holding on to them, but the investor participation in buyback of shares is voluntary and he may choose not to tender his shares. Under the Tender Offer route, Promoters, Promoter Group and Persons acting in Concert have an option to participate in the Buy-back. The promoters may or may not exercise this option.
2) Buyback through Open offer: The Company buybacks its shares in the open market over an extended period of time either through the stock exchange or book building route. Under these open market purchases, the company specifies a maximum price and buys back shares from the market during a defined time period. Promoters cannot participate in this route.
Reason for Buyback of Shares
Companies are increasing resorting to Buyback of their shares at a price higher than market price for reasons which may include:
1) As a Tax efficient way of rewarding the shareholders. While a section of shareholders may get cash, other shareholders also stand to benefit as company’s profits are now distributed across a smaller number of shares. The pack in this category is lead by IT Companies . Lled by margin expansion and a strong Dollar, these companies have increasing resorted to large sized buybacks. At least for some of these companies share buybacks seems to have overtaken dividends as a preferred way to return cash to shareholders.
2) Companies which have huge cash reserve or have made windfall profits like sale of an asset or division, also many times like to distribute the same though Buyback offers. Example Unichem Laboratories buyback in March 2018 after it sold of its domestic formulations division to Torrent Pharma.
3) To provide an additional exit route to shareholders when shares are under valued on the exchanges or are thinly traded.
4) Share Buybacks can also be used to shore up a company’s’ stock that may be trading at a huge discount in the market or to support the share price during sluggish market conditions.
Buyback as an Arbitrage Opportunity for Retail Investors:
Apart from existing investors in company, Buyback of Shares also presents an opportunity to other market participants. This opportunity arises because the chances of shares being accepted are higher for retail investors compared to institutional investors or promoters due to the 15 per cent minimum reservation norm. Thus Retail investors can use the buy back opportunity to purchase additional share which many times are ruling well below the Buyback price announced and tender a portion of these shares at a higher price (Buyback price) to the company. The more shares are accepted at the Buyback offer price, the higher is the benefit for the investor. The remaining shares are many times sold off by a short term investor at the price which may be ruling after completion of buyback.
An investors stands to gain if the amount from buyback of shares by company plus the amount realized by selling remaining shares in the market subsequently add up to more than his initial investment. He may very well end up in a loss too due to variety of factors.
This is illustrated by the actual example of HCLTECH 2017 Buyback:
- On 20 March 2017, HCLTECH Board approved Buyback of 350 Lakh shares amounting to Rs. 3500 crore at a price of Rs. 1000 each.
- An Investor with intent of short term arbitrage, purchased 200 shares of the company on the next day on which the stock was ruling at Rs. 864. He made an investment of Rs. 1,72,800.
- The Company after the end of record date made an offer to investor whereby he was entitled to offer 80 shares ( Entitlement ration was 8 out of 20 shares)
- Against this the investor offed all 200 shares to the company for Buyback. The company accepted 136 shares . The acceptance ratio was 68.34% as against the entitlement ratio of 8 out of 20 i.e. 40% as all investors did not participate in the buyback.
- The investor realized Rs. 1,36,000 as a result of buyback of shares. He sold the remaining 64 shares at the prevailing market price of Rs. 847 on 29th June 2017 and realized Rs. 54208 from this transaction. Thus his total realization was Rs. 1,90,208.
- The investor on an investment of Rs. 172800 ended up with Rs. 1,90,208 in a span of 3 months. In this period he made a gain of Rs. 17,408 on an investment of Rs 1,72,800 translating to an absolute return in the region of 10%.
Procedure for Participating in the Buyback Offer
- A company first announces a share buyback of a specified amount, indicating the number of shares it wishes to purchase back from shareholders and the price of buyback per share
- This company’s board proposed a buyback which is subject to approval of the shareholders s by means of a special resolution through a postal ballot.
- A company making a buyback offer announces a record date for the purpose of determining the entitlement and the names of the security holders, who are eligible to participate in the proposed buyback offer.
- The letter of offer along with the tender form is dispatched to shareholders who are eligible to participate in the buyback offer which they may have to provide to his broker to facilitate his participation in the buyback.
- The acquirer or promoter facilitates tendering of shares by the shareholders and settlement of the same, through the stock exchange mechanism and the offer for buy back remains open for a period of minimum ten working days. An exchange say BSE Limited is appointed as the “Designated Stock Exchange” to provide a separate “Acquisition Window” to facilitate placing of sell orders by Eligible Sellers who wish to tender their Equity Shares in the Buyback.
- Eligible Shareholders who desire to tender their Equity Shares in the electronic form under the Buyback have to do so through their respective Selling Member(s) by indicating to such Selling Member(s) the details of Equity Shares they intend to tender under the Buyback. The Selling Member then places an order/bid on behalf of the Eligible Shareholder(s) who wish to tender Equity Shares in the Buyback using the Acquisition Window of the Stock Exchange.
- In actual practice the process of offering/tendering shares for buyback against ones entitlement is quite simple. The exact procedure of tendering varies from broker to broker and while some could ask for a copy of letter of offer/email from the company, others may do it just by seeing the holdings in the depository or on the basis of an email request or phone call from the investors. Some online sites have also started to provide facility to investors to submit their shares online for these buybacks. After this act, the shares offred for buyback will not show in the investors Demat account.
- The Shareholders will have to transfer their Equity Shares from the same demat account in which they were holding such Equity Shares as on the Record Date, and in case of multiple demat accounts, Shareholders are required to tender the applications separately from each demat account.
- Eligible Shareholders participation in the Buyback is voluntary. The eligible shareholders may choose to participate, in part or in full, and receive cash in lieu of the Equity Shares accepted under the Buyback, or they may choose not to participate. Eligible Shareholders may also tender a part of their Buyback Entitlement and also have the option of tendering Additional Equity Shares (over and above their Buyback Entitlement) and benefit from any shortfall created due to non participation of some other Eligible Shareholders.
- The company accept shares or other specified securities from the security holders on the basis of their entitlement as on record date and makes payment of consideration to those security holders whose offer has been accepted. The remaining shares are returned back to the security holders Demat account within seven working days of the closure of the offer.
Common Terms used in Buyback of Shares
- Board Meeting for Buyback of Shares: The company which intends to go for Buyback of its shares, first sends an information to Stock exchanges of the same and intimates a date of Board meeting whereby the Buyback Details like Size of Buyback, Price of buyback, Route to be followed etc. are taken up and subsequently intimated to the stock exchanges.
- Retail Quota in Buybacks: This quota is minimum 15% of the total shares offed for Buyback. SEBI has mandated a reservation of 15 per cent of the buyback offer for retail investors with holding of up to Rs. 2 lakh (market value as on record date fixed for buyback).
- Entitlement Ratio: Based on number of investors on record date set for buyback, the company sends a letter of offer to shareholders through post or email mentioning their holding on the cut off date and the shares they are entitled to offer in the buyback. For a retail shareholder this is the ratio of number of shares held by him on record date divided by total retail quota for the buyback. The shareholder is assured of at least this number and is free to offer less than or more than this number (maximum limited by his holding on record date). In the example given earlier in the post for HCLTECH buyback 2017, the retail shareholders were entitled to sell 8 out of every 20 shares held by them .i.e. 40% entitlement ratio.
- Acceptance Ratio: This is the ratio of shares accepted by the company to the shares offered by the investor for buyback. The more shares are accepted at the Buyback offer price, higher is the acceptance ratio and higher is the benefit to the investor. For the the example given earlier in the post for HCLTECH buyback 2017, the acceptance ratio for retail retail shareholders stood around 68% which means out of every 100 shares offered by retail investors to the company for Buyback, 68 were accepted and accounted for at the buyback price while the rest 32 were returned to them.
Regulations Related to Buyback
- As per SEBI Guidelines, at least 15 percent of the securities a company proposes to buy back,should be reserved for small shareholders, while the maximum limit is capped at 25 percent of the paid-up capital.
- As per proviso to section 68 (2) of the Act, the Board of directors of a company can authorize the buyback of shares (share buyback) involving payment of consideration not exceeding 10% of the total paid up equity share capital and free reserves (including securities premium account) of the Company by a ordinary resolution. Member approval by a special resolution at a general meeting is required if the buyback is more than 10% of paid up capital and free reserves of the Company.
- Further under under the above Act, the number of Equity Shares that can be bought back during a financial year shall not exceed 25% of the number of equity shares of the Company.
- After buyback, debt equity ratio should not exceed 2:1 (Secured and unsecured debts after buy back shall not be more than twice of paid up capital & free reserves)
- All the shares considered for Buyback should be fully paid up.
- Minimum time Gap between two buy backs must be atleast one year. Within 6 months from date of completion of buy back, company shall not issue any fresh shares (Excludes Bonus shares/conversion of warrants/stock option/conversion of preference shares).
Standard disclaimer: I am not a SEBI registered analyst and above analysis is for educational purpose only. I may have vested interest in every stock I discuss and my views may be biased. Please do your own due diligence as stock market investments have high degree of inherent risk.