‘Tis the season of buybacks! Companies such as Wipro, TCS (Tata Consultancy Services), NTPC Limited (National Thermal Power Corporation) and NMDC Limited (National Minerals Development Corporation) are currently in the process of repurchasing their own shares from us investors. Sounds a bit counter-intuitive, doesn’t it? Why would a company buy back its own shares from us? What does the term, “buyback” mean? And does it benefit us in any way?
These are some of the questions that I’m going to answer for you today.
What is a buyback?
A buyback is a scheme by which a company repurchases a certain number of its own shares from its shareholders. Further, the price that the company offers us shareholders for this repurchase is higher than the market price.
Let’s take TCS, for example. This leading IT services company has decided to buyback around 5.33 crore shares (1.4% of its total number of shares) at ₹3,000 per share. But the market price (as of December 18) is around ₹2,867 per share.
Why is TCS offering a premium to shareholders for selling their shares back to the company? And should we sell at all?
Reasons for a buyback
There are mainly four reasons why companies go for a buyback of shares.
- When companies have excess cash, with little or no opportunities to deploy this cash elsewhere, buybacks are a great solution. A buyback enables the company to utilize its free reserves and other permitted sources of funds, channelling these funds back to investors. This act in turn boosts investors’ confidence in the company.
- Buybacks help companies consolidate their ownership. In simple words, when the promoters of the company want to increase their stake in the company, buybacks are the answer. This is especially true when companies foresee takeover threats.
- Buybacks are also a signal that the company’s shares are undervalued in the market and that the management is confident of the company’s future growth.
- Shareholder value goes up with a buyback. The shares that are repurchased by the company are extinguished. This reduces the number of shares in circulation, thereby increasing the earnings per share.
For instance, let’s say XYZ Ltd. originally had 1000 shares, of which the company repurchased 50 shares in a buyback offer. The earnings were at ₹50,000, which meant that originally, the earning per share was ₹50. After the buyback, the earnings remain unchanged, but the total number of shares is now 950. So, the new earnings per share is ₹52.63.
How do buybacks work?
Practically, companies can opt for either one of the following processes to see a buyback through:
- Tender Offer
Under this route, the company fixes the buyback price and buyback period. The buyback price is usually higher than the current market price and the period is usually ten days to a few weeks. During this time, shareholders are given an option to sell the shares at this higher price. Well-established companies usually go for this route.
- Open Market
Here, the company decides the maximum price per share. They then buy back shares from the market over a longer duration, say six months. Even though the maximum price is fixed, it is not necessary that every shareholder can sell at that price. Usually smaller companies take this route since the expenses involved throughout the buyback process are lower.
Now, we’ve looked at buybacks from the perspective of the company. But what about from a shareholder’s perspective?
Do buybacks benefit us investors?
As we noted earlier, buybacks can increase shareholder value. When a company announces a buyback, it usually sends out a positive signal to investors, the market, and the economy as a whole. But market prices fluctuate, especially in the short-term. So whether a buyback benefits us or not depends on the kind of returns we expect to make from our investment.
Say I have 100 shares of TCS. Should I sell my shares in the buyback offer? This is not an easy decision to make. I’ll give you three scenarios:
- I’m a long-term investor. I believe that TCS is going to perform well over the next decade. And I’ve decided that I don’t want to sell any of my shares. Remember, a buyback is optional, so I can very well stay invested, without reducing my shareholding. Who knows, ten years from now, the share price of TCS could be at ₹5,000!
- I’m a long-term investor, but I don’t have to sell all my 100 shares. I’ve decided to sell only 5 shares, get some funds and still stay invested with 95 shares.
- I’m a short-term investor, or trader, so I need to make sure that the buyback offer price really makes sense for me, since I might have only recently bought the shares. It’s also important to factor in tax implications. The profits I make from the sale will be subject to short-term capital gains tax.
All in all, the decision to sell shares in a buyback offer is subjective. What is good to know is that the overall impact of a buyback tends to be positive, irrespective of your decision as an investor.
Over the next few weeks, TCS, NTPC, NMDC, Wipro and a few other companies have their buyback offers lined up. One could view buybacks as a kind of reverse IPO (Initial Public Offering). And whether we take active part in this process or not, it sure is going to be an interesting time for us, if only to observe how the market reacts to such events.
