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Share buybacks: How does a company benefit from buying back shares

'Share buyback' has become the buzz word after the recent announcements of IT majors Cognizant and TCS to buy back shares. In fact, recent reports have suggested that Infosys may follow a similar strategy and announce a share buy back of $2.5 billion (Rs 17,000 crore) in April.  Following the trend, now world's largest coal producer, Coal India confirmed that the board of its arm Northern Coalfield has given go ahead to a share buyback plan worth Rs 1,244 crore.

"Board of Directors of Northern Coalfields Limited (NCL), our wholly-owned subsidiary ... has considered and approved the buyback of 76,356 fully paid equity shares of face value of Rs 1,000 each from the members of NCL on a proportionate basis through tender offer," Coal India Ltd said in a BSE filing.

But what are share buybacks and why are the companies are opting for it? Let's find out.

What is the objective?

The primary objective of a share buyback programme is to arrest the fall in the value of a stock by reducing the supply of the stock, which essentially pushes up the share price through a better P/E multiple. The other objective is to improve earnings per share (since the same dividend amount is now distributed among fewer shares).  Share buyback is a more tax efficient way of distributing earnings of the company. While dividends under Rs 10 lakh are not taxable in the hands of shareholders, companies have to pay tax on dividends. A share buyback program is a more tax efficient way of distributing earnings from a company's perspective.

What are the benefits?

There are many benefits of a buyback. With the reduction in the number of shares in the market, the earnings per share (EPS) increase. And because the company spends cash to buys its stock, the cash assets on its balance sheets reduce. This increases the RoE (return on equity). Shareholders who sell their stocks in the repurchase programme earn the market value plus a premium (if offered). The residual value for the remaining shareholders also goes up. Of course, it helps to up the promoter's stake in the company, assuming non-participation by promoters.

What are the processes involved?

A company can buyback through a either a tender offer or through the open market. In a tender offer, the company makes an offer to buy a certain number of shares at a specific price, directly from shareholders. In the open market option, the company buys up to a certain number of shares (no compulsion to buy the whole announced quantity); a maximum price is fixed and the buyback can be done upto or below that particular price, not beyond.

An open market buyback offer can generally go on for a year, whereas a tender offer gets executed in a shorter period of time. It can be interpreted that the intention behind a buyback through open market option is to buy as many shares as possible (within the overall limit fixed) at as low a price as possible; thus, trying to increase remaining shareholders' value to the maximum (without too much consideration to value received by selling shareholder). In case of a fixed price buyback, the intention is to give a reasonable price to selling shareholders, along with creating longer term value for remaining shareholders.

What were the recent big share buybacks?

Even before TCS and Cognizant, corporate India has been on a shopping spree. Between April and October 2015-16, 19 buyback offers were made - the highest in the last two fiscal years - according to Prime Database. Things looked more impressive in terms of the amount raised through buybacks - a massive Rs 26,353 crore, the highest in over a decade.

But what prompted an increase in the number of buybacks, which is a likely phenomenon of a bear market? "The trigger was the government's disinvestment programme to meet targets," says Pranav Haldea, Managing Director, Prime Database.

Nearly 65 per cent of the amount acquired through buy backs was contributed by public sector units (PSUs), including Coal India, NMDC, and MOIL. Since majority of them are cash-rich PSUs, leveraging cash through buybacks improves shareholders returns. Coal India acquired Rs 3,650 crore, NMDC got Rs 7,527.7 crore and National Aluminium amassed Rs 2,834.9 crore through buybacks.

A few multinational companies were also in the buyback race. Novartis India bought back 38,20,000 shares and Bosch acquired 8,78,160 shares. In a buyback process, companies purchase their own shares from shareholders at a pre-decided price that leads to reduction in capital base and higher earnings per share.