What is Share Buyback and why do companies do it ? | Espresso


What is share buyback and why do companies do it?

February 10, 2022
What is share buyback and why do companies do it?

What is share buyback and why do companies do it ?

Share buybacks have become a routine practice in the business world. A share buyback is an alternative form of shareholder distribution where a company decides to purchase its own shares back from existing shareholders. This, in effect, reduces the number of outstanding shares in the market. Usually, share buybacks are priced a notch higher than the prevailing market rate. Since the company's value remains the same, a buyback often results in an increase in the share price.

This corporate action allows companies to invest in themselves. The reduction in the number of outstanding shares will effectively increase the proportion of shares owned by investors. Usually, when a company feels its shares are being undervalued, it may buy back its shares to give its investors some return.

Types of share buyback

A public-listed company can buy back its shares in two ways:

1) Open Market

In this type, the company can simply buy its own shares in the open market. Open-market repurchasing, however, is an inefficient way to restructure the company's balance sheet. The daily limit on the number of shares a company can buy can drag the process indefinitely.

2) Tender Offer

The other alternative is to float a tender offer, where the company informs its shareholders that it wants to purchase shares at a certain price. Each investor can then choose to sell shares at that price. In some cases, the company may set a price range for the tender offer. Interested investors can quote their price within that range. The company will purchase the shares at the lowest cost.

Why do companies plan a buyback?

Companies may choose to buy back shares for several reasons:

  • A primary reason to do so is to improve the company's valuations. The reduction in the outstanding shares due to the buyback improves the earnings per share (EPS) and return on equity.
  • When there is too much cash on the books, and the opportunities for investments are limited, companies choose to go for a buyback. Typically, IT companies sitting on a massive amount of cash reward their shareholders with buybacks. Another reason is that buybacks are more tax-effective for shareholders than dividends.
  • Generally, when companies announce buybacks, they send strong signals to their investors. Given that the buyback price is above the current price of the stock, it gives a good indication of the growth prospects of the company.

One of the most recent examples of a share buyback is the offer from information technology major Tata Consultancy Services (TCS). The company said the buyback is part of its policy to focus on returning capital to shareholders.

TCS announced a buyback offer worth Rs 18,000 crore in January 2021. The IT bellwether is looking to buy back 4 crore equity shares at Rs 4,500 per share. This price is at a nearly 15% premium over the current stock price. The buyback size is equivalent to 1.08% of the total paid-up equity share capital.

This is TCS’ fourth share buyback since 2017. A year ago, the cash-rich company had announced a similar buyback offer worth Rs 16,000 crore.

The share buyback, under the tender offer route, is subject to shareholder approval through a special resolution through a postal ballot. The process, timelines and other details regarding the buyback are yet to be made public. The buyback is in addition to the third interim dividend of ? 7 per share that the company announced during its third-quarter results.

According to the pre-buyback shareholding pattern of the company, nine promoter entities hold 72.19%. While banks, mutual funds and insurance companies account for 7.8%, FPIs and FIIs held a 15.23% stake in the company. The shareholding of retail investors stood at about 3.88 per cent.

The Bottom Line

Whether stock buybacks are beneficial for investors remains a debatable topic in the long run. But before considering buying into a buyback, investors should do thorough due diligence over the company's financials and find out how it stacks up against key metrics like cash flow, revenue growth and return on equity.

R. Kalyanaraman
by R. Kalyanaraman

Chief Executive Officer

I am a sales guy at heart with utmost willingness to listen to people – customers, employees, competitors et al. Nothing gets me a bigger adrenaline rush than an interesting conversation with my customer!