Buy back of shares

INTRODUCTION TO THE INDIAN CAPITAL MARKET

Competitive forces with the unleashing of the liberalization policies have made
corporate restructuring a sine quo non for survival and growth. Operational, financial and
managerial strategies are employed to maintain competitive edge and turnaround a sickened
performance.
Financial restructuring involves either internal or external restructuring (i.e. Mergers
and Acquisitions). In the internal restructuring an existing firm undergoes through a series of
changes in terms of composition of assets and liabilities.
Section 100-105 of The Company's Act 1956 governs the internal restructuring of a
corporate entity in the form of capital reduction. Section 77A, 77B and 77AA now allow
companies to buy back their shares following the recommendations of committee on
corporate restructuring, which was set up by the government to propose various strategies to
strengthen the competitiveness of the banking and finance sector, companies are now allowed
to repurchase their own shares.
This will enable the companies to catch up with other developed markets as part of
the government's moves to liberalize the local market and hence emerged the concept of
SHARE BUY BACK in the Indian corporate scenario.
Relative to the Indian context, the listing of various foreign players in the earlier times
on the Indian bourses was regulatory driven. They had adequate funds in their kitty to pursue
their own goals, both in terms of funding their expansion and an inherent ability to outsource
and avail economic costs of production.
In the 1970’s period, if MNC’s wanted to continue doing their business in India, they
could do so only by diluting their shareholding and getting listed on the exchange. They were
thus forced to go public. Now that the norms have been altered and they are permitted to
carry on their business without any such compulsion, they would rather operate as wholly
owned subsidiaries without being listed on the bourses

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 Buy back of shares

BUY BACK OF SHARES

Buy back of equity shares is a capital restructuring process. It is a financial strategy that
allows a company to buy back its equity shares and other securities. In a changing economic
scenario corporate sector demands more freedom in restructuring debt-equity mix in times of
favorable business environment.

So far it was possible to refund shareholders' money through capital reduction process. A
company could buy back own shares obtaining permission of the Company Law Board under
the old provisions of the Companies Act, 1956. By virtue of the newly inserted section 77A
to the Companies Act, 1956 through the Companies (Amendment) Ordinance, 1999, a new
vista has been opened for flexible capital structuring by companies as and when necessary
without involvement of any external regulatory mechanism.

Buy back is a financial strategy - it should be used accordingly. It is not for improving
controlling interest of the ruling shareholding group. However, improvement of controlling
interest occurs as a natural consequence of buy back strategy.

In India, companies are lowly levered because of high incidence of debt cost. But so
long a company can earn above the effective debt cost it is advantageous to create favorable
leverage effect.

Creating shareholders' value should be the primary objective of corporate

management. It is difficult to service a large equity and add shareholders' value. Slimming
of capital structure should be an objective of buying back of own shares by companies. Buy
back offers a straight route for swapping equity for debt. In a situation when equity appears
to be costlier to debt, this would help to reduce overall cost of capital.

Prior to introduction of flexible buy back facility; once a particular equity pattern is
opted for it would become sacrosanct. To alter the skewed equity a company has to build up
the level of free reserves or to infuse more borrowed funds. Infusion of more borrowed fund
would be possible in a growth situation.

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 Buy back of shares
In a no-growth situation changing the equity structure was very difficult. Buy back option is
expected to help to correct the positively skewed equity share capital in the existing capital
structure of a lowly levered company that earns stable return.
If' a company cannot deploy the surplus cash in a growth process from which it would
be able to maintain average return on capital employed (ROCE) and earnings per share
(EPS), what should it do with the cash? Inter corporate investments/loans although freed
may not likely to improve average ROCE of the company. Board of directors is the
custodian of shareholder’s money. If it cannot add better value or, even maintain the current
rate of value addition, it should refund the money to the shareholders. This will at the same
time create better value to the leftovers. Good corporate governance demands proper
utilization of shareholder’s money. The buying back of outstanding shares (repurchase) by
a company in order to reduce the number of shares on the market. Companies will buyback
shares either to increase the value of shares still available (reducing supply), or to eliminate
any threats by shareholders who may be looking for a controlling stake.
A buyback is a method for company to invest in itself since they can't own
themselves. Thus, buybacks reduce the number of shares outstanding on the market which
increases the proportion of shares the company owns. Buybacks can be carried out in two
ways:

1. Shareholders may be presented with a tender offer whereby they have the option to submit
(or tender) a portion or all of their shares within a certain time frame and at a premium to the
current market price. This premium compensates investors for tendering their shares rather
than holding on to them.

2. Companies buy back shares on the open market over an extended period of time.

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 Buy back of shares

Restriction that has been lifted

Section 77(l) of the Companies Act, 1956 prohibited (i) a company limited by shares, and (ii)
a company limited by guarantee and having share capital to buy its share.

Section 77(2) of the Companies Act, 1956 disallowed a public company or a private
company, which is a subsidiary of a public company to give any direct or indirect financial
assistance to any person in the form of-

Loan
Guarantee
Provision for security or
In any other manner

for purchase of its own shares or of its holding company.

However, redemption of redeemable preference shares under section 80 of the Companies

Act, 1956 were not subjected to this restriction.

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 Buy back of shares

Disadvantage of the capital reduction route

Capital reduction is possible for diminution of liability in respect of the unpaid amount of
share capital or payment to any shareholder of any paid-up share capital. If repayment of a
portion of share capital is the purpose; that can be fulfilled through capital reduction.

However, it is not an easy route. It requires an order of court, which in turn requires
fulfillment of the following conditions-

The existing creditors should not object to the capital reduction;

All claims of the creditors who object to the capital reduction should be settled; or
their claims should be provided for;

Contingent or unascertained claims as fixed by the court should be provided for.

This route involves court process and is not flexible. It cannot be exercised as a financial
strategy. To the contrary, buy back is a flexible approach by which a company can safeguard
payment of outside liabilities before exercising buy back.

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 Buy back of shares
TERMS RELATED TO BUYBACK OF SHARES

 Anti-Dilution Provision:
A provision in an option or a convertible security. It protects an investor from
dilution resulting from later issues of stock at a lower price than the investor
originally paid. Also known as an "anti-dilution clause".

These are common with convertible preferred stock, which is a favored form
of venture capital investment.

 Convertible Preferred Stock:

Preferred stock that includes an option for the holder to convert the preferred
shares into a fixed number of common shares, usually anytime after a predetermined
date. Also known as "convertible preferred shares".

Most convertible preferred stock is exchanged at the request of the

shareholder, but sometimes there is a provision that allows the company (or issuer) to
force conversion. The value of convertible common stock is ultimately based on the
performance (or lack thereof) of the common stock.

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 Buy back of shares
 Diluted Earnings Per Share (Diluted EPS):
A performance metric used to gauge the quality of a company's earnings per share (EPS) if
all convertible securities were exercised. Convertible securities refers to all outstanding
convertible preferred shares, convertible debentures, stock options (primarily employee
based) and warrants. Unless the company has no additional potential shares outstanding
(a relatively rare circumstance) the diluted EPS will always be lower than the simple EPS.
Remember that earnings per share is calculated by dividing the company's profit by the
number of shares outstanding. Warrants, stock options, convertible preferred shares, etc. all
serve to increasing the number of shares outstanding. As a shareholder, this is a bad thing. If
the denominator in the equation (shares outstanding) is larger, the earnings per share is
reduced (the same profit figure is used in the numerator).
This is a conservative metric because it indicates somewhat of a worst-case scenario. On one
hand, everyone holding options, warrants, convertible preferred shares, etc.
is unlikely convert their shares all at once. At the same time, if things go well, there is a good
chance that all options and convertibles will be converted into common stock. A big
difference in a company's EPS and diluted EPS can indicate high potential dilution for the
company's shares, an attribute almost unanimously ostracized by analysts and investors alike.

 Venture Capital:
Financing for new businesses. In other words, money provided by investors to startup firms
and small businesses with perceived, long-term growth potential. This is a very important
source of funding for startups that do not have access to capital markets. It typically entails
high risk for the investor, but it has the potential for above-average returns.

Venture capital can also include managerial and technical expertise. Most venture capital
comes from a group of wealthy investors, investment banks and other financial institutions
that pool such investments or partnerships. This form of raising capital is popular among new
companies, or ventures, with limited operating history, who cannot raise funds through a debt
issue. The downside for entrepreneurs is that venture capitalists usually get a say in company
decisions, in addition to a portion of the equity.

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 Buy back of shares

 Book Value Of Equity Per Share (BVPS):

A financial measure that represents a per share assessment of the minimum value of a
company's equity. More specifically, this value is determined by relating the original value of
a firm's common stock adjusted for any outflow (dividends and stock buybacks) and inflow
(retained earnings) modifiers to the amount of shares outstanding.

Calculated as:

While book value of equity per share is one factor that investors can use to determine whether
a stock is undervalued, this metric should not be used by itself as it only presents a very
limited view of the firm's situation. BVPS provides a snap shot of a firm's current situation,
but considerations of the firm's future are not included. For example, XYZ Corp, a widget
producing company, may have a share price that is currently lower than its BVPS. This may
not indicate that the XYZ is undervalued, because looking ahead, the growth opportunities
for the company are vastly limited as fewer and fewer people are buying widgets.

 Book Value:
The value at which an asset is carried on a balance sheet. In other words, the cost of
an asset minus accumulated depreciation. The net asset value of a company, calculated by
total assets minus intangible assets (patents, goodwill) and liabilities. The initial outlay for an
investment. This number may be net or gross of expenses such as trading costs, sales taxes,
service charges and so on. In the U.K., book value is known as "net asset value".

Book value is the accounting value of a firm. It has two main uses:
1. It is the total value of the company's assets that shareholders would theoretically receive if
a company were liquidated.
2. By being compared to the company's market value, the book value can indicate whether a
stock is under- or overpriced.

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 Buy back of shares
3. In personal finance, the book value of an investment is the price paid for a security or debt
investment. When a stock is sold, the selling price less the book value is the capital gain (or
loss) from the investment.

 Dividend:
A distribution of a portion of a company's earnings, decided by the board of directors,
to a class of its shareholders. The dividend is most often quoted in terms of the dollar amount
each share receives (dividends per share). It can also be quoted in terms of a percent of the
current market price, referred to as dividend yield. Mandatory distributions of income and
realized capital gains made to mutual fund investors.

Dividends may be in the form of cash, stock or property. Most secure and stable companies
offer dividends to their stockholders. Their share prices might not move much, but the
dividend attempts to make up for this.High-growth companies rarely offer dividends because
all of their profits are reinvested to help sustain higher-than-average growth. Mutual funds
pay out interest and dividend income received from their portfolio holdings as dividends to
fund shareholders. In addition, realized capital gains from the portfolio's trading activities are
generally paid out (capital gains distribution) as a year-end dividend.

 Intrinsic Value:
The actual value of a company or an asset based on an underlying perception of its
true value including all aspects of the business, in terms of both tangible and
intangible factors. This value may or may not be the same as the current market value. Value
investors use a variety of analytical techniques in order to estimate the intrinsic value of
securities in hopes of finding investments where the true value of the investment exceeds its
current market value. For call options, this is the difference between the underlying stock's
price and the strike price. For put options, it is the difference between the strike price and the
underlying stock's price. In the case of both puts and calls, if the respective difference value
is negative, the intrinsic value is given as zero.

For example, value investors that follow fundamental analysis look at both qualitative
(business model, governance, target market factors etc.) and quantitative (ratios, financial

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 Buy back of shares
statement analysis, etc.) aspects of a business to see if the business is currently out of favor
with the market and is really worth much more than its current valuation.
Intrinsic value in options is the in-the-money portion of the option's premium. For example,
If a call options strike price is $15 and the underlying stock's market price is at $25, then the
intrinsic value of the call option is $10. An option is usually never worth less than what an
option holder can receive if the option is exercised.

 Market Value:
The current quoted price at which investors buy or sell a share of common stock or a
bond at a given time. Also known as "market price". The market capitalization plus the
market value of debt. Sometimes referred to as "total market value".

In the context of securities, market value is often different from book value because the
market takes into account future growth potential. Most investors who use fundamental
analysis to pick stocks look at a company's market value and then determine whether or not
the market value is adequate or if it's undervalued in comparison to it's book value, net assets
or some other measure.

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 Buy back of shares
 Tangible Book Value Per Share (TBVPS):
A method of valuing a company, on a per-share basis, by measuring its equity after removing
any intangible assets. The tangible book value per share is calculated as follows:

A company's tangible book value looks at what common shareholders can expect to
receive if the firm went bankrupt and all of its assets were liquidated at their book
value. Intangible assets, such as goodwill, are removed from this calculation, since they
cannot be sold during liquidation. Companies with high tangible book value per share provide
shareholders with more insurance in case of bankruptcy.

 Outstanding Shares:
Stock currently held by investors, including restricted shares owned by the company's
officers and insiders, as well as those held by the public. Shares that have been repurchased
by the company are not considered outstanding stock. Also referred to as "issued and
outstanding" if all repurchased shares have been retired.

This number is shown on a company's balance sheet under the heading "Capital
Stock" and is more important than the authorized shares or float. It is used to calculate many
metrics, including market capitalization and earnings per share (EPS).

 Share Repurchase:
A program by which a company buys back its own shares from the marketplace, reducing the
number of outstanding shares. This is usually an indication that the company's management
thinks the shares are undervalued.

Because a share repurchase reduces the number of shares outstanding (i.e. supply), it
increases earnings per share and tends to elevate the market value of the remaining shares.
When a company does repurchase shares, it will usually say something along the lines of,
"We find no better investment than our own company."

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 Buy back of shares

 Earnings Per Share (EPS):

The portion of a company's profit allocated to each outstanding share of common stock. EPS
serves as an indicator of a company's profitability.

Calculated as:

In the EPS calculation, it is more accurate to use a weighted-average number of shares

outstanding over the reporting term, because the number of shares outstanding can change
over time. However, data sources sometimes simplify the calculation by using the number of
shares outstanding at the end of the period. Diluted EPS expands on the basic EPS by
including the shares of convertibles or warrants outstanding in the outstanding shares
number.

Earnings per share are generally considered to be the single most important variable in
determining a share's price. It is also a major component of the price-to-earnings valuation
ratio. For example, assume that a company has a net income of $25 million. If the company
paid out $1 million in preferred dividends and had 10 million shares for one half of the year
and 15 million shares for the other half, the EPS would be $1.92 (24/12.5). First, the $1
million is deducted from the net income to get $24 million. Then a weighted average is taken
to find the number of shares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).

An important aspect of EPS that's often ignored is the capital that is required to generate the
earnings (net income) in the calculation. Two companies could generate the same EPS
number, but one could do so with less equity (investment) - that company would be more
efficient at using its capital to generate income and, all other things being equal, would be a
"better" company. Investors also need to be aware of earnings manipulation that will affect

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the quality of the earnings number. It is important not to rely on any one financial measure,
but to use it in conjunction with statement analysis and other measures.

 Return On Equity (ROE):

A measure of a corporation's profitability that reveals how much profit a company
generates with the money shareholders have invested.

Calculated as:

Also known as "return on net worth (RONW)".

The ROE is useful for comparing the profitability of a company to that of other firms in the
same industry.There are several variations on the formula that investors may use:

1. Investors wishing to see the return on common equity may modify the formula above by
subtracting preferred dividends from net income and subtracting preferred equity from
shareholders' equity, giving the following: return on common equity (ROCE) = net income -
preferred dividends/common equity.

2. Return on equity may also be calculated by dividing net income by average shareholders'
equity. Average shareholders' equity is calculated by adding the shareholders' equity at the
beginning of a period to the shareholders' equity at period's end and dividing the result by
two.
3. Investors may also calculate the change in ROE for a period by first using the shareholders'
equity figure from the beginning of a period as a denominator to determine the
beginning ROE. Then, the end-of-period shareholders' equity can be used as the
denominator to determine the ending ROE. Calculating both beginning and ending ROEs
allows an investor to determine the change in profitability over the period.

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 Buy back of shares
 Price-Earnings Ratio (P/E Ratio):
A valuation ratio of a company's current share price compared to its per-share earnings.

Calculated as:

For example, if a company is currently trading at $43 a share and earnings over the last 12
months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95). EPS is
usually from the last four quarters (trailing P/E), but sometimes it can be taken from the
estimates of earnings expected in the next four quarters (projected or forward P/E). A third
variation uses the sum of the last two actual quarters and the estimates of the next two
quarters. Also sometimes known as "price multiple" or "earnings multiple".

In general, a high P/E suggests that investors are expecting higher earnings growth in the
future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the
whole story by itself. It's usually more useful to compare the P/E ratios of one company to
other companies in the same industry, to the market in general or against the company's own
historical P/E. It would not be useful for investors using the P/E ratio as a basis for their
investment to compare the P/E of a technology company (high P/E) to a utility company (low
P/E) as each industry has much different growth prospects. The P/E is sometimes referred to
as the "multiple", because it shows how much investors are willing to pay per dollar of
earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is
that an investor is willing to pay $20 for $1 of current earnings. It is important that investors
note an important problem that arises with the P/E measure, and to avoid basing a decision on
this measure alone. The denominator (earnings) is based on an accounting measure of
earnings that is susceptible to forms of manipulation, making the quality of the P/E only as
good as the quality of the underlying earnings number.

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 Buy back of shares

 Price-To-Book Ratio (P/B Ratio):

A ratio used to compare a stock's market value to its book value. It is calculated by dividing
the current closing price of the stock by the latest quarter's book value per share. Also known
as the "price-equity ratio".

Calculated as:

A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that
something is fundamentally wrong with the company. As with most ratios, be aware this
varies by industry. This ratio also gives some idea of whether you're paying too much for
what would be left if the company went bankrupt immediately.

 Price/Earnings To Growth (PEG Ratio):

A ratio used to determine a stock's value while taking into account earnings growth. The
calculation is as follows:

PEG is a widely used indicator of a stock's potential value. It is favored by many over
the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower
PEG means that the stock is more undervalued. Keep in mind that the numbers used are
projected and, therefore, can be less accurate. Also, there are many variations using earnings
from different time periods (i.e. one year vs five year). Be sure to know the exact definition
your source is using.

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 Buy back of shares

 Trailing Price-To-Earnings (Trailing P/E):

The sum of a company's price-to-earnings, calculated by taking the current stock price and
dividing it by the trailing earnings per share for the past 12 months. This measure differs
from forward P/E, which uses earnings estimates for the next four quarters. The trailing P/E
ratio is calculated as follows:

This is the most commonly used P/E measure because it is based on actual earnings and,
therefore, is the most accurate. However, stock prices are constantly moving while earnings
remain fixed. As a result, forward P/E can sometimes be more relevant to investors when
evaluating a company.

 Price/Earnings to Growth and Dividend Yield (PEGY Ratio):

A variation of the price-to-earnings ratio where a stock's value is further evaluated by its
projected earnings growth rate and dividend yield.

Calculated as:

For stocks that pay a substantial dividend, the PEGY may be an even better measure than
PEG. As with the PEG, keep in mind the numbers are based on future projections and
therefore, aren't guaranteed to be accurate. PEGY is pronounced the same way as "peggy."

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SOURCES OF BUY BACK

A company can buy back its own shares or other specified securities out of three sources:

Free reserves
Securities premium account
Proceeds of an earlier issue of shares or other specified securities. [Section 77A(l)].

Buy back of any kind of shares is not allowed out of the proceeds of any earlier issue of the
same kinds of shares.

Free reserve
Meaning of Free Reserves

The term free reserve has been defined to carry same meaning as has been assigned in clause
(b) of Explanation to section 372A. For the purpose of section 372A the term 'free reserve'
has been defined as those reserves which as per the latest audited balance sheet are free for
distribution as dividend and it includes balance of securities premium account. Free reserve
means the balance in the share premium account, capital and debenture redemption reserves
shown or published in the balance sheet of the company and created by appropriation out of
the profits of the company.

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Securities premium Account

Securities Premium Account is a broader term than Share Premium Account. Share Premium
account represents only premium on issue of equity and preference shares, whereas securities
premium account represents premium on issue of debentures, bonds and other financial
instruments.

Proceeds of an earlier issue

Buy back of shares of any kind is not allowed out of fresh issue of shares of the same kind. If
it were so, it would frustrate the very purpose of buy back. Fresh issue of equity shares for
buying equity makes no financial sense. However, financial logic of buy back could very well
be served if preference shares are issued and proceeds are used for buying back equity shares.

Preference shares carry fixed rate of dividend. Also they are easy to market.
Preference shares may give better yield to the investor than after tax yield on loan or
debentures. At the same time it is possible to lever the capital structure by slimming the
dividend paying equity.

That apart buy back of shares is allowed utilizing proceeds of an earlier issue. Proceeds of an
earlier issue is an unqualified term. Any issue means any issue of hybrid instruments,
debentures, bonds, secured and unsecured loans etc. Thus buy back of equity shares is
allowed byissue of any pure or hybrid debt instruments.

Then appropriate source of buy back should be the following if the intention is to swap equity
for debt or fixed income bearing instruments:
Issue of debentures;
Issue of loans.

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 Buy back of shares
Buy Back sourcing caution

While approving the buy back resolution the following points should be carefully scrutinized
as regards cash flow linkage of free reserve and securities premium account as they are not
necessarily represented by free cash:

How much of the free reserve and securities premium account are readily available in
the form of free cash?

Whether owned investments in current assets are released for buy back? If so, its
impact on current ratio?

Whether non-trade investments will be disposed to generate free cash? If yes, what is
the possible profit/loss?

If trade investments are proposed to be sold, what is the possible adverse impact on
operating activities?

If any fixed assets are sold, whether it has been intended to reduce the scale of
operation of the company

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 Buy back of shares
Buyback Conditions:

Section 77A(2) of the Companies Act,1956 requires that buy back should be carried out if-

• Authorized by its articles;

• A special resolution has been passed in the general meeting of the company authorizing
the buy back;

• The buy back does not exceed twenty-five per cent of the paid u capital and free
reserves of the company; also a company cannot buy back more than twenty-five per
cent of its paid-up equity capital in any financial year;

• The ratio of the debt owed by the company is not more than twice the capital and its

free reserves after such buy back;

• All the shares or other specified securities are fully paid up;

• Buy back of shares or other securities listed on any recognized stock exchange
should be carried out in accordance with the Regulations made by the Securities
and Exchange Board of India in this behalf;

Buy back of shares or other securities other than those specified in the clause above
should be carried out in accordance with the Guidelines as may be prescribed.

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PUBLIC ANNOUNCEMENTS

Public announcement is an important communication to the shareholders detailing out the

buy back. Although buy back is approved by special resolution in the general meeting, it is
expected that shareholders are aware of the buy back proposal of the company through
explanatory statement attached to the notice of the meeting, but there is no requirement to
ensure that the resolution should be informed to the shareholders.

Thus public announcement is the formal communication about the approved buy back
proposal of the company. It has been discussed in Chapter Three that as per SEBI
Regulations a company should not withdraw from buy back offer once public announcement
is made or draft offer letter is filed with the SEBI.

In case of tender offer, public announcement precedes submission of draft offer letter to the
SEBI. Draft offer letter is required to be submitted within seven days from date of public
announcement. The same course should be followed in case of buy back of odd lots. In case
of buy back through stock exchange operation, copy of the public announcement is submitted
to the SEBI and it should be made at least seven days prior to the buy back.

The same process is to be followed for buy back through book building process except that a
copy of the public announcement should be submitted to the SEBI within two days from the
date of announcement.

The contents of the public announcement should cover the items mentioned in Schedule H to
the SEBI Buy Back Regulations, 1998. The merchant banker appointed for buy back is
responsible for ensuring that contents of the public announcement are true, fair and not
misleading.

Information content of the public announcement provides advance information to the

shareholders about the buyback. This information is also incorporated in the draft offer letter.

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 Buy back of shares
Disclosures To Be Made In The Letter Of Offer
The letter of offer shall, inter-alia, contain the following:

1. Details of the offer including the total number and percentage of the total paid up
capital and free reserves proposed to be bought back and price;

2. The proposed time table from opening of the offer till the extinguishment of the
certificates;

3. Authority for the offer of buy-back;

4. A full and complete disclosure of all material facts including the contents of the
explanatory statement annexed to the notice for the general meeting at which
the special resolution approving the buy back was passed;

5. The necessity for the buy back;

6. The process to be adopted for the buy back;

7. The minimum and the maximum number of securities that the company proposes to
buy-back, sources of funds from which the buy-back would be made and the
cost of financing the buy-back;
8. Brief information about the company;

9. Audited Financial information for the last 3 years and the company and its Directors
shall ensure that the particulars (audited statement and un-audited statement)
contained therein shall not be more than 6 months old from the date of the
offer document together with financial ratios as may be specified by the Central
Government ( as per the amendment effective from March 2000 ) ;

10. Present capital structure (including the number of fully paid and partly paid securities)
and shareholding pattern;

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11. The capital structure including details of outstanding convertible instruments, if any,
post buy-back;

12. The aggregate shareholding of the promoter group and of the directors of the
promoters, where the promoter is a company and of persons who are in control
of the company;

13. The aggregate number of equity shares purchased or sold by persons mentioned in
clause (xii) above during a period of twelve months preceding the date of the
public announcement and from the date of public announcement to the date of the
letter of offer; the maximum and minimum price at which purchases and sales
referred to above were made alongwith the relevant date;

14. Management discussion and analysis on the likely impact of buy back on the
company's earnings, public holdings, holdings of Non Resident
Indians/Foreign Institutional Investors, etc., promoters holdings and any change
in management structure;

15. The details of statutory approvals obtained;

16.
i. A declaration to be signed by at least two whole time directors that
there are no defaults subsisting in repayment of deposit. Redemption of
debentures or preference shares or repayment of a term loans to any financial
institutions or banks;

ii. A declaration to be signed by at least two whole time directors, one of

whom shall be the managing director stating that the Board of Directors has made
a full enquiry into the affairs and prospectus of the company and that they have
formed the opinion-

a. As regards its prospects for the year immediately following the

date of the letter of offer that, having regard to their intentions with respect to the
management of the company's business during the year and to the amount and

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 Buy back of shares
character of the financial resources which will in their view be available to the
company during that year, the company will be able to meet its liabilities and will
not be rendered insolvent within a period of one year from the date;

b. In forming their opinion for the above purposes, the directors

shall take into account the liabilities as if the company were being wound up
under the provisions of the Companies Act, 1956 (including prospective and
contingent liabilities)

17. The declaration must in addition have annexed to it a report addressed to the directors
by the company's auditors stating that-

a. They have inquired into the company's state of affairs, and

b. The amount of permissible capital payment for the securities in question is in

their view properly determined; and

c. They are not aware of anything to indicate that the opinion expressed by the
directors in the declaration as to any of the matters mentioned in the declaration is
unreasonable in all the circumstances.

18. Such other disclosures as may be prescribed by the Central Government from time to
time.

19. The offer document shall be dated and signed by the Board of Directors of the
company.

20. The letter of offer shall contain pre and post buy-back debt equity ratios (As per the
amendment effective from March 2000 this clause has been inserted)

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 Buy back of shares

EXTINGUISHMENT OF CERTIFICATE

The company shall extinguish and physically destroy the share certificates so bought
back in the presence of a Registrar or the Merchant Banker, and the Statutory Auditor
within seven days from the date of acceptance of the shares.

The shares offered for buy-back if already dematerialised shall be extinguished and
destroyed in the manner specified under Securities and Exchange Board of India
(Depositories and Participants) Regulations,1996 and the bye-laws framed there under.

The company shall furnish a certificate to the Board duly verified by

The registrar and whenever there is no registrar through the merchant banker;
Two whole-time Directors including the Managing Director and,
The statutory auditor of the company, and certifying compliance as specified in
sub-regulation (1), within seven days of extinguishment and destruction of the
certificates.

The particulars of the share certificates extinguished and destroyed under sub-
regulation (1) shall be furnished to the stock exchanges where the shares of the company
are listed within seven days of extinguishment and destruction of the certificates.

The company shall maintain a record of share certificates which have been cancelled
and destroyed as prescribed in sub-section (9) of section 77A of the Companies Act,.

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 Buy back of shares

SHARE BUY-BACK: OBJECTIVES

A company may decide to buy back its shares for one of the following reasons:

To return surplus cash to shareholders as an alternative to a higher dividend payment.

The management may also like to return surplus cash to the shareholders in the form
of buy back when there are no proper investment opportunities to maintain the rate of
return.

Adjust or change the company's capital structure quickly, say for those companies
seeking to increase its debt/equity ratio. Buyback facilitates reduction of share capital
without recourse to lengthy capital reduction process.

To increase earnings per share and net asset value per share as a possible signal to the
market place that management is of the view that the prospects of the company justify a
market price higher than that currently accorded by the market.

• To improve the liquidity of the shares and other performance parameters like
EPS,DPS, operating cash flow per share,etc

Initially many companies may opt for equity financing to avoid high financial risk. At
a later stage when the company becomes successful in stabilizing its income, it may
prefer to have a levered capital structure to ensure better return on equity.

Buyback can be used as a mechanism for maintaining shareholder’s value in a

situation of poor state of secondary market. Buyback announcement may temporarily
arrest the downtrend.

It is a mechanism to balance equity after the conversion of debt or preference share

capital.

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 Buy back of shares
To thwart the attempts of a hostile takeover. The maximum limit of shares that a
company can buy back in a financial year is 25% of the total equity and the fund exposure
is limited to 25% of the net worth or 100% of the free reserves, whichever is more.
Pricing for buyback has been left to the discretion of the company.

A company may buy back equity shares through proportionate basis (tender route) or
from the open market. Buyback is reckoned as an important tool to defeat buy-back of
shares since the bought back shares are cancelled and a promoter is in a position to
consolidate and strengthen his position. For example, a company X, which has the
following shareholding pattern is facing a hostile takeover bid :

Promoters
30%
Public Promoters
45% FIs
Public
FIs
25%

If the company proposes to buyback 25% of the total equity, then the post buyback holding of
the promoters would be straight away consolidating their position to 40%. With the support
of financial institutions the acquirer could be made to beat a hasty retreat.

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 Buy back of shares
BUYBACK OF SHARES UNDER INDIAN COMPANIES ACT
1956

The provisions regulating buy back of shares are contained in Section 77A, 77AA and
77B of the Companies Act,1956. These were inserted by the Companies (Amendment)
Act,1999. The Securities and Exchange Board of India (SEBI) framed the SEBI(Buy Back of
Securities) Regulations,1998 and the Department of Company Affairs framed the Private
Limited Company and Unlisted Public company (Buy Back of Securities) Regulations,1998
pursuant to Section 77A(2)(f) and (g) respectively.

 Objectives of Buy Back:

Shares may be bought back by the company on account of one or more of the following
reasons:
• To increase promoters holding.
• Increase earning per share.
• Rationalize the capital structure by writing off capital not represented by available
assets.
• Support share value.
• To thwart takeover bid.
• To pay surplus cash not required by business.

 Resources of Buy Back:

A Company can purchase its own shares from

(i) free reserves; Where a company purchases its own shares out of free reserves, then a sum
equal to the nominal value of the share so purchased shall be transferred to the capital
redemption reserve and details of such transfer shall be disclosed in the balance-sheet or

(ii) securities premium account; or

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 Buy back of shares

(iii) proceeds of any shares or other specified securities. A Company cannot buyback its
shares or other specified securities out of the proceeds of an earlier issue of the same kind of
shares or specified securities.

 Conditions of Buy Back:

(A) The buy-back is authorised by the Articles of association of the Company;

(B) A special resolution has been passed in the general meeting of the company authorising
the buy-back. In the case of a listed company, this approval is required by means of a postal
ballot. Also, the shares for buy back should be free from lock in period/non
transferability.The buy back can be made by a Board resolution If the quantity of buyback is
or less than ten percent of the paid up capital and free reserves;

(C) The buy-back is of less than twenty-five per cent of the total paid-up capital and fee
reserves of the company and that the buy-back of equity shares in any financial year shall not
exceed twenty-five per cent of its total paid-up equity capital in that financial year;

(D) The ratio of the debt owed by the company is not more than twice the capital and its free
reserves after such buy-back;

(E) There has been no default in any of the following

i. in repayment of deposit or interest payable thereon,

ii. redemption of debentures, or preference shares or

iii. payment of dividend, if declared, to all shareholders within the stipulated time of 30 days
from the date of declaration of dividend or

iv. repayment of any term loan or interest payable thereon to any financial institution or bank;

(F) There has been no default in complying with the provisions of filing of Annual Return,
Payment of Dividend, and form and contents of Annual Accounts;

(G) All the shares or other specified securities for buy-back are fully paid-up;

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 Buy back of shares
(H) The buy-back of the shares or other specified securities listed on any recognised stock
exchange shall be in accordance with the regulations made by the Securities and Exchange
Board of India in this behalf; and

(I) The buy-back in respect of shares or other specified securities of private and closely held
companies is in accordance with the guidelines as may be prescribed.

 Disclosures in the explanatory statement:

The notice of the meeting at which special resolution is proposed to be passed shall be
accompanied by an explanatory statement stating –
I. A full and complete disclosure of all material facts.
II. The necessity for the buy-back.
III. The class of security intended to be purchased under the buy-back.
IV. The amount to be invested under the buy-back.
V. The time-limit for completion of buy-back.

 Sources from where the shares will be purchased:

The securities can be bought back from

(A) Existing security-holders on a proportionate basis;

Buyback of shares may be made by a tender offer through a letter of offer from the holders of
shares of the company or

(B) The open market through

(i) Book building process;
(ii) Stock exchanges or

(C) Odd lots, that is to say, where the lot of securities of a public company, whose shares are
listed on a recognized stock exchange, is smaller than such marketable lot, as may be
specified by the stock exchange; or

(D) purchasing the securities issued to employees of the company pursuant to a scheme of
stock option or sweat equity.

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 Buy back of shares

 Filing of Declaration of solvency:

After the passing of resolution but before making buy-back, file with the Registrar and the
Securities and Exchange Board of India a declaration of solvency in form 4A. The
declaration must be verified by an affidavit to the effect that the Board has made a full
inquiry into the affairs of the company as a result of which they have formed an opinion that
it is capable of meeting its liabilities and will not be rendered insolvent within a period of one
year of the date of declaration adopted by the Board, and signed by at least two directors of
the company, one of whom shall be the managing director, if any: No declaration of solvency
shall be filed with the Securities and Exchange Board of India by a company whose shares
are not listed on any recognized stock exchange.

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 Buy back of shares
 Register of securities bought back:
After completion of buyback, a company shall maintain a register of the securities/shares so
bought and enter therein the following particulars:
A. The consideration paid for the securities bought-back,
B. The date of cancellation of securities,
C. The date of extinguishing and physically destroying of securities,
Such other particulars as may be prescribed,
Where a company buys-back its own securities, it shall extinguish and physically destroy the
securities so bought-back within seven days of the last date of completion of buy-back.

 Issue of further shares after Buy back:

Every buy-back shall be completed within twelve months from the date of passing the special
resolution or Board resolution as the case may be. A company which has bought back any
security cannot make any issue of the same kind of securities in any manner whether by way
of public issue, rights issue up to six months from the date of completion of buyback.

 Filing of return with the Regulator:

A Company shall, after the completion of the buy-back file with the Registrar and the
Securities and Exchange Board of India, a return in form 4 C containing such particulars
relating to the buy-back within thirty days of such completion. No return shall be filed with
the Securities and Exchange Board of India by an unlisted company.

 Prohibition of Buy Back:

A company shall not directly or indirectly purchase its own shares or other specified
securities –

(A) Through any subsidiary company including its own subsidiary companies; or
(B) Through any investment company or group of investment companies;

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 Buy back of shares

Procedure for buy back:

A. Where a company proposes to buy back its shares, it shall, after passing of the
special/Board resolution make a public announcement at least one English National Daily,
one Hindi National daily and Regional Language Daily at the place where the registered
office of the company is situated.

B. The public announcement shall specify a date, which shall be "specified date" for the
purpose of determining the names of shareholders to whom the letter of offer has to be sent.
C. A public notice shall be given containing disclosures as specified in Schedule I of the
SEBI regulations.

D. A draft letter of offer shall be filed with SEBI through a merchant Banker. The letter of
offer shall then be dispatched to the members of the company.

E. A copy of the Board resolution authorising the buy back shall be filed with the SEBI and
stock exchanges.

F. The date of opening of the offer shall not be earlier than seven days or later than 30 days
after the specified date.

G. The buy back offer shall remain open for a period of not less than 15 days and not more
than 30 days.

H. A company opting for buy back through the public offer or tender offer shall open an
escrow Account.

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 Buy back of shares

 Penalty:
If a company makes default in complying with the provisions the company or any officer of
the company who is in default shall be punishable with imprisonment for a term which may
extend to two years, or with fine which may extend to fifty thousand rupees, or with both.
The offences are, of course compoundable under Section 621A of the Companies Act, 1956.

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 Buy back of shares

RECOMMENDATIONS & FINDINGS

What should you look at before participating in buybacks?

Ever since the buyback of shares was allowed in India, there has been a lot of confusion
among shareholders; as whether to sell-off their stake in the company or to retain it. To opt
for a particular option is not as easy as it appears. The perception of the shareholders about
the future of the company is the most important factor that influences their decision.

However, that decision may not be accurate since they might not have complete access to the
internal and external strategies of the company. A lot of careful thought has to be given
before a final decision is taken. Here’s a way on how to go about it.

Debt-equity ratio is an important criterion. The companies having high debt

burden are unlikely to have free cash. They should prefer redeeming their debt first, to
buying back equity. MNCs having subsidiaries in India are unlikely to have any motive of
rigging up the share price and their buyback offer is likely to be genuine.

Track record of raising capital in the past. Companies that have frequented the
capital markets to raise money are unlikely to be good candidates for buyback.

Look at ROCE/RONW-The companies with consistently high ROCE/RONW

are more likely to have free cash than others.

Checkout the previous price pattern of the share Companies generally

tend to buyback shares at a higher premium over the market price if they feel that their
shares are under-priced. This decision to buyback often leads to an increase in share price.
At this stage, you have to analyse the fluctuation in the price of the scrip for a specific
time period (say one year) and if you find that the scrip moved a band lower than the offer
price, selling of the scrip would be a better option.

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 Buy back of shares
Take note of Irrationality A buyback offer with a huge premium may appear
very attractive. Investigate and ensure that any temporary negatives do not affect the
share price. If you feel that the share prices of the company are presently undervalued,
refrain from selling, since a company buying back its shares is indirectly conveying that
its shares are undervalued.

Take a long-term perspective It would be difficult to envisage whether a

company would issue bonus or split shares or make an acquisition. But these factors can
be sidelined if the fundamentals of the company are strong and you expect the company
to perform well in the future. Therefore, in the long-term perspective, the scripts of such
companies should not be sold.

Dispose off volatile shares Despite strong fundamentals, the shares of a few
companies are highly volatile and exhibit wild oscillation in prices. If you want to play it
safe and avoid volatility, selling out would be a better option.

Selling off for profit The first question that comes to mind once you decide to sell
your scrip is whether to opt for a buyback or to sell it in the market. Even after buyback is
announced, the purchase price need not necessarily be the highest if a price band is given.
Further, there is no guarantee that all the shares offered for buyback would be bought.
Companies mostly buy about 10% of the equity in buybacks. In such cases it would be
wiser to sell your stake in the market at a time when prices of your scrip are trading at a
price equivalent to the highest in the offer band.

Finally, one should keep one thing in mind, that buyback has no impact on the fundamentals
of the company or on the economy. The only thing is that one should be cautious of
unscrupulous promoters' traps and do not fall prey to them.

The provision to allow buyback can be a booty for long-term investors who want to stick on
in good companies, but it can be a terrible bait in many others.

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 Buy back of shares
Caution is advised in the following types of companies:

Where the management talks about buyback, as market has not valued their
shares fully. To my mind, a good management will never bother about its share price and
valuation as done by the market. It would know that if it continues to perform well, the
market has to take notice in the long term.

Where the management has passed, with a lot of publicity, special resolutions
empowering the Board to buy back whenever allowed. Anybody with the genuine
intention of buying back to enhance shareholders' wealth would try to do so with
minimum publicity so that the share price does not flare up.

Buyback has no impact on the fundamentals of the economy or companies. Investors should
be cautious of unscrupulous promoters' traps.

To sell or not to sell?

When confronted with a buyback offer, one shouldn’t just be guided by the offer price in
relation to the prevailing market price. Yes, if you were looking to exit the stock anyway,
that’s perhaps all you need to look at. However, if you are a medium- to long-term investor in
the company, you also need to weigh the implications of the buyback on the company and its
stock–and, therefore, your investment.

Earnings per share (EPS).

Post-buyback, the EPS of a company is bound to increase due to a reduction in equity.
However, going forward, the EPS could fall if the performance of the company
deteriorates, or if the funds used for the buyback earned significant additional income for
the company.

Hence, future prospects of the company ought to be your biggest consideration while
evaluating its buyback offer. If the company is expected to record healthy growth, it pays
to stay invested in it. However, if it is expected to founder, exiting might be a better

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 Buy back of shares
option. This fact is borne out by the contrasting post-buyback numbers of two companies
that have bought back stock in recent times, Bajaj Auto and GE Shipping .

Adjusted for the buyback, Bajaj Auto’s EPS increased from Rs 51.4 to Rs 60.7. However,
soon after, for the financial year ended March 2001, its EPS fell to Rs 25.9 due to a
decline in two-wheeler sales from 1.43 million units to 1.2 million units.

Book value.
This is the per-share value of the company’s assets as valued in its books. Other things
remaining constant, you stand to gain by exiting if the buyback price paid by the company
is above its book value. However, if the price paid by the company to buy back its stock
is less than its book value, you gain by staying on.

Bajaj Auto made its tender offer at Rs 400 per share, a premium of almost 50 per cent to
its pre-buyback book value of Rs 268 per share. As a result, post-buyback, the company’s
book value dropped 3 per cent to Rs 260 per share. Since the premium came from its
existing reserves, residual shareholders actually ended up sharing the cost of the premium
paid.

Return on equity (RoE).

Post-buyback, the net worth the company must service decreases. Even if the company
does not expand its bottom line considerably, this would result in an improved RoE for
residual shareholders.

But an increase in RoE that results from a reduction in the net worth, as opposed to an
increase in earnings, may just end up being a one-time improvement. Hence, look at the
company’s track record on RoE and also assess its future earnings potential before
choosing to stay on as a residual shareholder in it.

Promoter’s stake. A buyback increases the promoter’s stake in his company.

When a buyback is announced, look at the stake of the promoter and his associates in the
company, before and after the buyback (assuming the offer is fully subscribed).

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 Buy back of shares
Cash-rich companies where the promoters have a low holding and are keen to increase
their stake could well make further buyback offers at a later date–often, at a higher price.
There are many old economy companies that fit this profile. A good example is GE
Shipping. In January this year, the company announced a Rs 150 crore buyback from the
market at a maximum price of Rs 42 per share. It completed the buyback at an average
price of Rs 35 per share, and the Sheths hiked their stake from 17 per cent to 21 per cent.

GE Shipping is currently in the midst of its second buyback exercise. It has earmarked Rs
100 crore to buy back equity at a maximum price of Rs 42 per share. At that price, the
Sheths’ holding in the company will rise to 25.8 per cent.

However, given the weak stock market and the recent downturn in the shipping industry, the
stock is languishing near Rs 23, and the company might well complete the buyback paying
less than Rs 100 crore. In better times, though, the same buyback could have been closer to
the offer price.

However, when a company makes a buyback with the prime intention to increase its
promoters’ stake, it’s dipping into its net worth without necessarily meaning to increase
shareholder wealth. Therefore, you need to evaluate the impact the outflow of funds would
have on the company’s operations and whether this could be detrimental to future growth.

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 Buy back of shares

Price and liquidity.

A buyback rouses interest in a scrip. When done through open market purchases, it
creates a cap or floor for the stock. In a bullish market, the buyback price creates a floor
for the scrip in the secondary market. When Reliance offered to buy back its shares in
June 2000 at Rs 303 per share, this effectively became the floor price for the stock. The
stock traded below that level for just 11 days over the next 264 trading days, as market
players anticipated that Reliance would step in and make purchases if it dipped below Rs
303.

In a bearish market, though, this is reversed–the maximum buyback price becomes a

ceiling price for the scrip. Reliance never did pick any stock till June 2001 (when the
initial buyback approval lapsed). It took fresh approval, on the same terms. Post-
September 11, the scrip hasn’t breached Rs 303. In this bearish market, investors are not
inclined to pay more than what the management perceives to be a fair value for the stock.

A buyback has greater implications for investors in illiquid stocks, as it offers them a much-
needed exit route. However, post-buyback, liquidity in such stocks is likely to decline further
due to a drop in their free float. It’s not a good idea to hold an illiquid stock–low liquidity
results in poor price determination. In extreme cases, where a promoter’s holding crosses 90
per cent, the company has to delist. So, always keep in mind the promoter’s stake and the
stock’s free float in the market.

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 Buy back of shares
The bottomline.

Buybacks should be used as an opportunity to exit only when there is concern over a
company’s prospects or when the post-buyback free float is expected to shrink considerably.
In most other cases, buybacks do offer the lure of an immediate benefit–but you might be
better off as a residual shareholder, and gain from a hike in the share of assets and profits of
the business.

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 Buy back of shares
General obligations of a company resorting to buy back

The following are the general obligations of company, which has resorted to buy back:

Letter of offer, public information and other publicity material should contain true and
factual information. There should not be any misleading information.

Company should not issue any shares including bonus shares till the closure of the
offer. It may be mentioned that a company will not be entitled to issue shares on closure of
the offer excepting issue of bonus shares, in discharge of subsisting conversion liability,
sweat equity and issue of shares to ESOP.

The prohibition period should be earlier of the specified date or public announcement.
This is because although special resolution is passed, a company may eventually put off the
buy back decision.

Buy back consideration should be discharged only by way of cash.

No withdrawal from the buy back is allowed after the draft letter of offer is filed with
the SEBI or public announcement is made. This is to prevent creating market confusion
through futile buy back offer.

The promoters or persons in control of the company should not deal in shares of the
company in the stock exchange during the buy back offer period. The promoters and persons
having controlling interest cannot participate in the buy back through stock exchange
operation.

However, they are allowed to participate in tender offer or buy back through book
building. This is targeted to prevent the possibility of insider trading. However, this may not
be able to prevent any attempt to pull down the price by creating selling pressure during the
book building process.

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 Buy back of shares
Public announcement for buy back cannot be made during the tendency of any
scheme of amalgamation or compromise or arrangement. No purpose can be served by
this restriction, in normal Course; a company has been prevented during the period of
offer and during cooling period to issue shares. So if buyback starts the company will not
be in a position to discharge equity swapped amalgamation.

As a means of investors' protection Regulation 19(3) requires nomination of a

Compliance officer by the company who will ensure compliance with the legal aspects of
the buy back. This could be the responsibility of the merchant banker.

Buy back of shares which are in the lock-in period is not allowed till the tendency of
lock-in period and until the shares become transferable.

Publication of buy back information:

The company is required to make public announcement by way of

advertisement in a national daily within two days from the date of completion of the
buyback inter alias disclosing:
Number of shares bought back;
Price at which shares are bought back;
Total amount invested in the buy back;
Details of the shareholders from whom more than 1% of the shares are bought back;
Consequential changes in the capital structure and shareholding pattern before and after
buy back.

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 Buy back of shares
WHY COMPANIES BUYBACK THE SHARES?

• Unused Cash: If they have huge cash reserves with not many new profitable
projects to invest in and if the company thinks the market price of its share is
undervalued. Eg. Bajaj Auto went on a massive buy back in 2000 and Reliance's
recent buyback. However, companies in emerging markets like India have growth
opportunities. Therefore applying this argument to these companies is not logical.
This argument is valid for MNCs, which already have adequate R&D budget and
presence across markets. Since their incremental growth potential limited, they can
buyback shares as a reward for their shareholders.

* Tax Gains Since dividends are taxed at higher rate than capital gains companies prefer
buyback to reward their investors instead of distributing cash dividends, as capital gains tax is
generally lower. At present, short-term capital gains are taxed at 10% and long-term capital
gains are not taxed.

* Market perception By buying their shares at a price higher than prevailing market
price company signals that its share valuation should be higher. Eg: In October 1987 stock
prices in US started crashing. Expecting further fall many companies like Citigroup, IBM et
al have come out with buyback offers worth billions of dollars at prices higher than the
prevailing rates thus stemming the fall.

Recently the prices of RIL and REL have not fallen, as expected, despite the spat between the
promoters. This is mainly attributed to the buyback offer made at higher prices.

* Exit option If a company wants to exit a particular country or wants to close the
company.

* Escape monitoring of accounts and legal controls If a company wants to avoid

the regulations of the market regulator by delisting. They avoid any public scrutiny of its
books of accounts.

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 Buy back of shares
• Show rosier financials Companies try to use buyback method to show better
financial ratios. For eg. When a company uses its cash to buy stock, it reduces
outstanding shares and also the assets on the balance sheet (because cash is an asset).
Thus, return on assets (ROA) actually increases with reduction in assets, and return on
equity (ROE) increases as there is less outstanding equity. If the company earnings
are identical before and after the buyback earnings per share (EPS) and the P/E ratio
would look better even though earnings did not improve. Since investors carefully
scrutinize only EPS and P/E figures, an improvement could jump-start the stock. For
this strategy to work in the long term, the stock should truly be undervalued.

* Increase promoter's stake Some companies buyback stock to contain the dilution in
promoter holding, EPS and reduction in prices arising out of the exercise of ESOPs issued to
employees. Any such exercising leads to increase in outstanding shares and to drop in prices.
This also gives scope to takeover bids as the share of promoters dilutes. Eg. Technology
companies which have issued ESOPs during dot-com boom in 2000-01 have to buyback after
exercise of the same. However the logic of buying back stock to protect from hostile
takeovers seem not logical. It may be noted that one of the risks of public listing is
welcoming hostile takeovers. This is one method of market disciplining the management.
Though this type of buyback is touted as protecting over-all interests of the shareholders, it is
true only when management is considered as efficient and working in the interests of the
shareholders
.
* Generally the intention is mix of any of the above

* Sometimes Governments nationalize the companies by taking over it and then compensates
the shareholders by buying back their shares at a predetermined price. Eg. Reserve Bank of
India in 1949 by buying back the shares.

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 Buy back of shares

WHAT ARE THE METHODS IN WHICH BUYBACK CAN

HAPPEN?

Share buyback can take place in 3 ways:

1. Shareholders are presented with a tender offer where they have the option to submit a
portion of or all of their shares within a certain time period and at usually a price
higher than the current market value. Another variety of this is Dutch auction, in
which companies state a range of prices at which it's willing to buy and accepts the
bids. It buys at the lowest price at which it can buy the desired number of shares.
2. Through book-building process.
3. Companies can buy shares on the open market over a long-term period subject to
various regulator guidelines like SEBI.

In both 1 & 2 promoters can participate in buyback and not in 3.

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 Buy back of shares
RESTRICTIONS ON BUYBACK BY INDIAN COMPANIES

Some of the features in government regulation for buyback of shares are:

(1) A special resolution has to be passed in general meeting of the shareholders.

(2) Buyback should not exceed 25% of the total paid-up capital and free reserves.
(3) A declaration of solvency has to be filed with SEBI and Registrar Of Companies.
(4) The shares bought back should be extinguished and physically destroyed.

The company should not make any further issue of securities within 2 years, except bonus,
conversion of warrants, etc.

These restrictions were imposed to restrict the companies from using the stock markets as
short term money provider apart from protecting interests of small investors.

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VALUATION OF BUYBACK

There are two ways companies determine the buyback price. They use the average closing
price (which is a weighted average for volume) for a period immediately before to the
buyback announcement. Based on the trend and value a buyback price is decided.

In the 2nd, shareholders are invited to sell some or all of their shares within a set price range.
The low point of the range is at a discount to the market price, while the top of the price
range is set at a premium to the market price. Investors are given more say in the buyback
price than in the above arrangement. Still this method is rarely used. Generally, the price is
fixed at a mark up over and above the average price of the last 12-18 months.

Any manipulations?

* Some companies come out with a scheme of buyback wherein, unless the shareholders
rejected the offer specifically, in response to the offer letter sent by the company, they would
be deemed to have accepted it. Though courts have upheld the action of the companies, it is
to be noted that small shareholders generally do not bother to read such letters and respond to
the same, and may not understand the complex legal language used in such letters.

* Some companies make it compulsory for shareholders to sell at a specified price mandated
by the company. A shareholder enters a company by choice and mutual agreement and
should be entitled to exit only by choice. Forcible buyback of shares at a non-transparent
price would be expropriation and should be prevented. Note: GoI's budget of FY 2002-03 has
relaxed buyback rules for the companies by which buyback of shares up to 10% of paid-up
capital does not require shareholders approval thus putting the minority shareholders at the
mercy of majority shareholders and promoters.

Eg. MNCs listed on exchanges have taken this route in a big way in 2001-2003.

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CHECKLIST OF INVESTORS BEFORE ACCEPTING THE

BUYBACK OFFER

* Take a look at the share price movement immediately before the buyback. If there was a
significant rise, the prima facie assumption is that the promoters have been up to tricks.

* Debt-equity ratio: The companies aare hugely under debts are unlikely to have free cash.

* Companies that have just come to the capital markets to raise money are unlikely to be
good candidates for buyback.

* When the management has passed special resolutions, with a lot of publicity, empowering
the Board to buy back whenever allowed, there is enough scope for suspicion. Anybody with
the genuine intention of buying back to enhance shareholders' wealth would try to do so with
minimum publicity so that the share price does not flare up due to speculators.

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EFFECT OF BUYBACK ON STOCK EXCHANGE

Buyback may leads to abnormal increase of prices posing heavy risk to those who
value shares based on fundamentals. This may also lead to reduction in investor interest in the
market particularly with de-listing of good shares. Eg: It was feared in 2001-03 that de-listing
by many MNCs may drop the money flow to stock exchanges.

BUYBACK IN INDIA

In India the Buyback clause comes with certain clauses.

The main objective of these clauses is to prevent Promoters from malpractice. For
example with Buyback a co. might be able to improve its EPS & improve the Market value of
the scrip (assuming at constant P/E) & thereafter come up with an IPO at a higher premium to
shore up the Share Premium Account.

A promoter might be able to corner a substantial number of shares through open market
purchases (not triggering the Takeover code, however) & force the company to buy back
these shares at a higher price, making a clean profit in the process. To prevent such
malpractice the Working Group has recommended the following:

Any company that buy back its shares will not be allowed to issue fresh capital,
except bonus issue, for another 12 months if the shares are bought back & extinguished, and
for another 24 months if the shares are held as Treasury Stocks. This will prevent
manipulations of share prices through Buyback.
Promoters have to specify the amount to be used for Buyback & get prior approval of
shareholders.
Only Free Reserves are allowed to be utilized for the purpose of Buyback. It has been
argued hotly that a company will be rewarding the shareholders through a Buyback route as
well as it does through Bonus & Rights issue, Dividends, etc. If a company buys back the
shares and extinguishes them, its Equity decreases to that extent, thereby increasing its EPS.

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 Buy back of shares
It is been assumed that the market price of the share increases to match the pre-
Buyback price to the Earnings ratio. Buyback also helps a co. to maintain a target capital
structure. When the RONW of a co. is less than ROCE, it implies that the capital structure is
lopsided with excess Equity. The co. can buy back the Equity & replace it with Debt to
improve its RONW.

The key question that inevitably follows is that which is more beneficial to the
investors, a Dividend or a Buyback? This is a subjective question that depends on the market
price of the scrip & the price of repurchase.

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BUYBACK IN INDIA:
In India though many specified group cos. qualify for Buyback, at current prices, not
many of them will be able to utilize their cash flow to buy back their shares, as it will directly
affect their cash requirements for normal operations. Cash rich cos. like Reliance Industries,
Bajaj Auto, TISCO, TELCO, HLL, etc. will have to shell out huge amounts to buy back even
a fraction of their Equity at prevailing prices, which are obviously higher than the BV of the
shares.
The other problem is that most of the Indian cos. have a Debt-Equity ratio greater than one.
Buyback would definitely increase this ratio & reduce the leveraging capacity of the Co. This
is specially applicable to cos. having a high proportion of fixed assets, like TISCO &
TELCO. Coupled with the fact that the co. will not be able to issue new shares for at least one
year, this implies that the co. will not be able to go in for any expansion for the next one year
or so, this would be definitely a big dampener to the whole concept of Buyback.

It has been argued that in India Buyback will be used predominantly to ward-away
hostile takeover bids. However the utility of Buyback as a tool of defense In India is
questionable under the existing regulations. For example in the US, cos. are allowed to
borrow to buy back their shares in case of a takeover bid.

However in India a co. is not allowed to undertake fresh borrowings for the purpose
of Buyback. This means that weaker cos. which are inevitably takeover targets cannot resort
to Buyback as a defense mechanism.

The lacunae in the buyback guidelines need to be addressed like the applicability of
SEBI’s takeover code. A company buying back to a certain percentage, will it necessarily
have to comply with the SEBI Takeover Code regulations. For, on dilution, the proportion of
shares held by the promoters would increase and set off a trigger under Regulation 10 of the
SEBI Takeover Code.

Further, the takeover code gets triggered when shares beyond a specified threshold
limit are acquired. This entitles the acquirer to exercise a certain percentage of voting power.
In case of buybacks, there is no increased entitlement to voting rights. For, under Section 77
A (7) of the Companies Act, 1956, a company buying back its shares is not entitled to hold

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the same but has to statutorily cancel them. Hence, a share buyback may not entail triggering
of the takeover code. Also as per the provisions of the Indian Stamp Act 1899, share transfers
attract stamp duty and require the company to register the shares bought back in its name. In
case of buybacks, these shares have to be statutorily extinguished. Hence, they do not get
registered in the acquirer’s name. The names of the shareholders have to be struck off from
the register of members too. Hence stamp duty would not become payable in a share
buyback.

Further, in the case of foreign JV, where the government has permitted a fixed ratio of
investment, the Indian company has to maintain the same percentage in case of a buyback.
Recently, there have been reports that the government is proposing to exempt multinational
joint ventures from extinguishing shares bought back, provided the foreign equity holding in
the company is equal to sectoral caps post-buyback. This has not been brought into effect as
yet.
Given these pitfalls, Buyback as a concept & as a tool cannot make much headway
into the Indian corporate financial handbook. There have to be modifications in the existing
legal framework to make this concept work in India.

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PITFALLS
Share buybacks, if handled badly or in an imprudent manner can exacerbate a sinister
situation. The recent spates of buybacks at a torrid pace are leading to a flight of capital from
the stock markets. Buybacks coupled with mergers and acquisitions are gnawing at the free
float available to the investors.

The utilization of a company’s cash reserve to fund it’s re purchase plans, if viewed in
entirety also leads to reduced ploughing back of funds for fuelling operations and a higher
debt perspective on the balance sheet.

Many companies have in fact initiated borrowing to finance their buyback programs.
This might bestow upon the company various tax advantages but at the same time it amounts
to replacing equity with debt. Dividend yield may eventually lose importance as more and
more companies substitute their dividend plans with buyback plans. The company gets highly
leveraged and changes the shareholders perception of the company from being an income
stock to a growth stock.

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CONCLUSION:

While scrutinizing a buyback offer, attention must be paid to the size of the buyback
relative to the company’s free float and with the newly granted stock options. The buyback
announcements are a mere statement of the company’s intentions and need not necessarily be
effected in actuality. However, if the announcement is backed by a tender offer, the
possibility of the fulfillment of buyback promise does exist.

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WEBLIOGRAPHY

• www.blonnet.com
• www.advanishares.com
• www.indiainfoline.com
• www.google.com
• www.indiaheadlines.com
• www.indiainfo.com

Newspapers:
• The Times of India
• Business Standard
• Financial Express
• Business Line

BIBLIOGRAPHY
• Buyback of Shares – Ghosh
• Inter – CA module
• Financial Management- Prasanna Chandra

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