Tally

Share on Facebook

Share on Twitter

Share on LinkedIn

Share on Email

Share More


Untitled 1

As we are aware, Indian companies were not allowed to repurchase its own securities prior to coming into force of Companies (Amendment) Act, 1999. The said amendment inserted new sections 77A, 77AA and 77B into the Companies Act so as to enable Indian companies to repurchase its securities. The purpose of insertion of these provisions into the Companies Act was to enable the companies to get rid of their unwanted/surplus share capital through a process of repurchase for cancellation/extinguishment without having to resort to lengthy process of reduction of share capital under sections 100 to 104 of the Act through High Court approval. Needless to mention that buy back of shares does not amount to reduction of share capital under section 100 of the Act which requires High Court approval. The legal provisions relating to buy back are contained in Sections 77, 77A, 77AA and 77B of the Companies Act. Apart from these, listed companies desirous of buy back are required to comply with SEBI buy back regulations. Similarly, in case of unlisted public companies and private companies, separate regulations governing buy back have been framed.

Without going into the nitty gritty of legal and procedural aspects of buyback, an attempt is made in this article to highlight and analyze the benefits of buy back from the company as well as investor/shareholder point of view.

What is Buy Back?

Simply put, a buy back of shares is a process whereby a company seeks to repurchase its own securities from its existing shareholders directly through a tender offer or from open market, i.e. through stock exchange. In other words, buy back is akin to a company investing in itself.

Why do companies buy back their own securities?

Buy back of its own securities offers several benefits to the company, particularly on financial front.

Companies going for buy back may avail the following advantages/benefits:

1. Buy back enables companies to get rid of their surplus unwanted share capital without recourse to reduction of share capital through High Court route under sections 100 to 104 of the Companies Act.

2. Buy back entails repurchase of its own shares by a company which are subsequently extinguished, thus resulting in decrease in the number of outstanding shares. Consequently, Earning Per Share (EPS) improves which in turn leads to higher market value in the stock market since EPS closely influences market price of shares quoted on stock exchange. Let us consider the following scenario:

 

Pre-buy back

 Post buy back

Profits available to equity shareholders Rs. 1,00,000/- Rs. 1,00,000/-
No of shares 25,000 20,000
EPS  Rs. 4/-  Rs. 5/-

Thus, it is evident that buy back results in improvement in EPS due to decrease in number of outstanding shares assuming that earnings remains constant in post buy back scenario.

3. Higher EPS results in higher market value of shares which improves shareholders value in the long run.

4. As seen from the above, quite often buy back may be resorted to as a tool to pop up the stock prices whenever the company feels that its shares are undervalued in the stock market.

5. Buy back results in an improvement in overall return on assets (ROA). Buy back will result in dilution of cash which is an asset; consequently while there is reduction in value of assets to the extent of consideration paid for buy back, ROA will go up assuming that the earnings remain constant in pre-buy back and post buy back scenario.

6. Likewise, buy back would lower the P/E ratio in the wake of improvement in EPS. Lower P/E ratio is viewed positively in the stock market. Thus, improved EPS coupled with lower P/E ratio and higher ROA would have an overall positive impact on the stock prices.

7. Surplus/idle funds available with the company may be utilized for buy back when there are no suitable avenues to invest in the eyes of the management.

8. Usually, buy back from the open market is done at prices higher than the prevailing market prices i.e. at a premium, it sends a strong positive signal across the market that the shares of the company are undervalued and the company is willing to buy its own shares at higher than the ones quoted at the stock exchange.

9. Sometimes buy back may be resorted as a tool to increase promoters shareholding by diluting the subscribers capital. It may also be seen as a tool in the hands of MNC’s to convert their Indian operations/ventures into wholly owned subsidiaries through dilution of equity and thus increasing the promoters’ shareholding.

10. From the company perspective, buy back of shares is often seen as a tool to counter a hostile takeover bid.

How do shareholders benefitted from a buyback offer:

Having analyzed the advantages of buyback offer, let us now discuss the benefits of buy back from shareholders point of view:

1. Following the buyback, as already seen above EPS improves.

2. Improved EPS invariably leads to a surge in market prices of shares quoted on a stock exchange. This results in increase in the value of equity shareholding.

3. Buyback offer provides an easy exit route for the shareholders through which they can sell their shares to the company itself at a premium, i.e. higher than market prices. This is an attractive option for them particularly when shares of the company are undervalued.

4. Shareholders get their share of surplus cash available in the hands of the company.

5. Shareholders opting to stay with the company and not going for buy back are also benefitted since there is a possibility of higher dividends in the wake of reduction in number of outstanding shares.

As seen from the above, buyback offers a number of benefits to the company and to the shareholders. However, it is not all that rosy as it appears from the outside! In fact, buyback of shares may sometimes raise a few eye brows particularly from the investors’ side.

Let us now discuss some of the concerns that are normally cited against a buy back offer:

1. Experts feel that buyback may be misused by the MNCs to increase their stake in their Indian ventures thus reducing them to their wholly owned subsidiaries in order to escape from public scrutiny and regulatory environment.

2. Apart from the above, a usual concern is that buy back may be used as a tool to delist its shares by a company.

3. Minority shareholders express concern that they really have no option but to accept the offer once it is approved by the majority of shareholders.

4. Sometimes the stakeholders feel that the buy back price offered to them does not commensurate with the future profit potential of the company and a suitable reward for incurring opportunity cost.

5. Buyback may also have an impact on the stock exchanges resulting in substantial decline in the trading volumes.

Conclusion:

All the pros and cons of buyback discussed above, present quite an interesting platform to discuss who is benefited the most from a buyback deal. However, from what the author has discussed above, it can be safely concluded that notwithstanding a few concerns and exceptional cases, buyback is a win-win situation for both the companies as well as shareholders. The company and the shareholders stand to gain an equal weight from a buyback offer making it an attractive option for both of them. Yet, it cannot be overemphasized that in this era of corporate governance, companies before resorting to buyback must ask themselves- is it really necessary? Are we going to create wealth for the shareholders? In short, buyback should not be adhered to for any ulterior motives and the spirit and objective of the buyback law should be upheld by the companies.

CS Abhishek Goyal 




Category Corporate Law, Other Articles by - CS Abhishek Goyal 



Comments


update