Professional Documents
Culture Documents
SUBMITTED TO
UNIVERSITY OF MUMBAI
BY
ADITYA SUNIL BAGARKA
T. Y. B.M.S.
YEAR 2005-2006
THROUGH
TOLANI COLLEGE OF COMMERCE
ANDHERI (EAST), MUMBAI – 400 093
CERTIFICATE
my knowledge.
At the onset, I would like to thank the almighty who gave me determination
and patience throughout the compilation of this project.
Further, I would like to thank Mrs. Shalini Hemant for her help and guidance
without which this project would not have reached this point.
There is one person who has been a constant source of encouragement and
help, Mrs. Akshata Kadam, I hereby acknowledge all her efforts.
My parents and family has been a great source of motivation for me always; I
am deeply indebted with all the help and facilities they provided me with.
I would like to extend my gratitude to all the people whom I contacted with,
during the process of collecting information, for their valuable time and efforts
in explaining me the concept of BUY BACK.
Lastly, I thank all my friends for their support in all the possible ways.
3. Objectives 6–9
4. Sources 10 – 12
5. Methods 13 – 20
6. Public Announcements 21 – 23
7. Extinguishment of Certificate 24
14. Pitfalls 49
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.
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.
Over 300 companies, including the Tatas, the Birlas and Reliance, had
passed resolutions -- taken shareholders permission -- at their AGMs
during the year 1997-1998.
Sudden plethora…
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
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— Buy Back of Shares
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— Buy Back of Shares
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.
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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.
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— Buy Back of Shares
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
Objectives
The rationale behind buy back of shares is to boost demand by
reducing the supply, which in theory should push the price up. The
repurchase of shares reduces the number of shareholders, which in
turn enhances the earnings per share (EPS), and thus improves
investor sentiments.
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
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— Buy Back of Shares
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%
FIs : 25%
Public : 45%
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
The Law of Demand states that with an increase in demand, if supply does
not increase, the commodity can command a higher price. The same will be
true for shares too. With an increase in demand for the stock and a
corresponding decline in the available free float, the value of the stock will
tend to rise.
After the buyback has been effected, the proportional share of the existing
shareholders increases and thereby gives them a higher say and holding in
the company affairs.
High cash balance reflecting in the balance sheet, will tend to drag down a
few return ratios, like the Return on Assets (ROA), Return on Equity (ROE),
and so on. Freeing up the cash reserves will push these ratios to a higher
level, thereby reflecting a sound financial management practice.
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— Buy Back of Shares
Example 1
Let us now take a small example to understand the impact of buyback:
A company XYZ Ltd has an issued share capital of 1,000 shares of Rs. 100
each. XYZ Ltd is evaluating a buyback of 100 shares of Rs. 150 each, which
is priced at a slight premium to the current market price of Rs. 140 per share.
ABC group of shareholders holds all the 1,000 shares.
Under such a scenario, XYZ Ltd uses its cash reserve of Rs. 15,000 to buy
back 100 shares. The likely impact on XYZ Ltd would be:
• The EPS should increase as the earnings stream remains unaffected
except for the loss of interest on Rs. 15,000, but the number of shares has
reduced to 900.
• Demand for XYZ Ltd's shares should increase with now only 900 shares in
circulation, against 1000 shares before the buyback.
• Net assets of XYZ Ltd will decrease by Rs. 15,000, thus increasing the
gearing, but net assets per share should remain the same.
These factors should lead to an increase in the share price in one to two
years.
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— Buy Back of Shares
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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— Buy Back of Shares
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.
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
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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Methods
A company shall not buy back its shares from any person through negotiated
deals, whether on or off the stock exchange or through spot transactions or
through any private arrangement.
Buy back is not allowed through negotiated deals on or off the stock
exchange. It is possible to negotiate the price and number of shares and then
to complete the deal in the stock exchange. This does not give equal
opportunity to other shareholders who could have also preferred to tender
their shares at the same price.
This will help to check privately settled buy back deals. However, it is equally
difficult to trace the off market origin of a market settled transactions. Buy
back is not allowed through spot transactions or through any private
arrangement.
Any person or an insider shall not deal in securities of the company on the
basis of unpublished information relating to buy-back of shares of the
company.
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— Buy Back of Shares
In case the company opts for tender offer route for buy back, all the
shareholders whose names appear in the Register of Shareholders on the
specified date should be offered to tender their shares.
Special Resolution:
(I) For the purposes of passing a special resolution under sub-section (2) of
section 77A of the Companies Act, the explanatory statement to be
annexed to the notice for the general meeting pursuant to section 173 of
the Companies Act shall contain disclosures as specified in schedule I.
(II) A copy of the resolution passed at the general meeting under sub-section
(2) of section 77A of the Companies Act, shall be filed with the Board and
the stock exchanges where the shares of the company are listed, within
seven days from the date of passing of the resolution.
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— Buy Back of Shares
exchange.
• The company shall appoint a merchant banker and make a public
announcement in reference to the same.
• The public announcement shall be made at least seven days prior to the
commencement of buy-back.
• The deposit in the escrow account shall be made before the date of the
public announcement. (ii) The amount to be deposited in the escrow
account shall be determined with reference to the maximum price as
specified in public announcement.
• A copy of the public announcement shall be filed with the Board within two
days of such announcement along with the fees as specified in the
regulations.
• The public announcement shall also contain the detailed methodology of
the book-building process, the manner of acceptance, the format of
acceptance to be sent by the shareholders pursuant to the public
announcement and the details of bidding centers.
• The book building process shall be made through an electronically linked
transparent facility.
• The number of bidding centers shall not be less than thirty and there shall
be at least one electronically linked computer terminal at all the bidding
centers.
• The offer for buy back shall remain open to the shareholders for a period
not less than fifteen days and not exceeding thirty days.
• The merchant banker and the company shall determine the buy-back price
based on the acceptances received.
• The final buy-back price, which shall be the highest price accepted should
be paid to all holders whose shares have been accepted for buy-back.
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— Buy Back of Shares
The explanatory statement annexed to the notice under section 173 of the
Companies Act, shall contain the disclosures mentioned in regulation 5 and
also the following disclosures;
a. The price at which the buy-back of shares shall be made;
b. If the promoter intends to offer their shares,
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Offer procedure
1. The offer for buy back shall remain open to the members for a period not
less than fifteen days and not exceeding thirty days.
2. The date of the opening of the offer shall not be earlier than seven days or
later than thirty days after the specified date.
3. The letter of offer shall be sent to the shareholders so as to reach the
shareholders before the opening of the offer.
4. In case the number of shares offered by the shareholders is more than the
total number of shares to be bought back by the company, the
acceptances per shareholder shall be equal to the acceptances tendered
by the shareholders divided by the total acceptances received and
multiplied by the total number of shares to be bought back.
5. The company shall complete the verifications of the offers received within
fifteen days of the closure of the offer and the shares lodged shall be
deemed to be accepted unless a communication of rejection is made
within fifteen days from the closure of the offer.
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ESCROW ACCOUNT
1. The company shall as and by way of security for performance of its
obligations under the regulations, on or before the opening of the offer
deposit in an escrow account such sum as specified in sub-regulation (2).
2. The escrow amount shall be payable in the following manner-
• If the consideration payable does not exceed Rs.100 crores - 25% of
the consideration payable;
• If the consideration payable exceeds Rs. 100 crores – 25% upto Rs.
100 crores and 10% thereafter.
3. The escrow account referred in sub-regulation (1) shall consist of
• Cash deposited with a scheduled commercial bank or;
• Bank guarantee in favour of the merchant banker; or
• Deposit of acceptable securities with appropriate margin, with the
merchant banker,or
• A combination of all of above.
4. Where the escrow account consists of deposit with a scheduled
commercial bank, the company shall, while opening the account, empower
the merchant banker to instruct the bank to issue a banker’s cheque or
demand draft for the amount lying to the credit of the escrow account, as
provided in the regulations.
5. Where the escrow account consists of bank guarantee, such bank
guarantee shall be in favour of the merchant banker and shall be valid until
thirty days after the closure of the offer.
6. The company shall, in case the escrow account consists of securities,
empower the merchant banker to realise the value of such escrow account
by sale or otherwise and if there is any deficit on realisation of the value of
the securities, the merchant banker shall be liable to make good any such
deficit.
7. In case the escrow account consists of bank guarantee or approved
securities, these shall not be returned by the merchant banker till
completion of all obligations under the regulations.
8. Where the escrow account consists of bank guarantee or deposit of
approved securities, the company shall also deposit with the bank in cash
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Payment to shareholders
1. The company shall immediately after the date of closure of the offer open
a special account with a Bankers to an Issue registered with the Board and
deposit therein, such sum as would, together with the amount lying in the
escrow account make-up the entire sum due and payable as consideration
for buy-back in terms of these regulations and for this purpose, may
transfer the funds from the escrow account.
2. The company shall within seven days of the time specified in sub-
regulation (5) of regulation 9 make payment of consideration in cash to
those shareholders whose offer has been accepted or return the share
certificates to the shareholders.
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Public Announcements
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.
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— Buy Back of Shares
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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 dematerialized 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
In India, the debt equity ratio is greater than one for few companies and is
greater than two for even fewer companies. This is mostly guided by the f act
that cost of equity servicing is cheaper to cost of debt.
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— Buy Back of Shares
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— Buy Back of Shares
Cash flow available for debt servicing is determined by operating cash flow
net of tax payment plus income from investment and other income included in
the Cash Flow from Investment Activities. Cash flow from operating activities
is determined before charging depreciation and other non-cash expenses and
losses.
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— Buy Back of Shares
through borrowing.
• Dividend pay out ratio - When a company has reached a very high level
of dividend pay out ratio, which becomes unsustainable, it can cut the
dividend rate to reduce the market price and then it may adopt leveraged
buy back. A dividend cut will bring down equity cost and in the process of
leveraged buy back it can find a favourable drive out premium. This will
improve value of the non-tendering shareholders.
• Saving in dividend also reduces the cash flow matching problem for debt
servicing effectively.
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— Buy Back of Shares
Relevance of pricing
Buy back pricing has many facets depending on the method deployed for buy
back. In tender offer, a company announces fixed price at which shares to be
tendered. There is no choice left to the tendering shareholders. Of course, to
be successful the buy back offer price should be better than the comparative
market price.
Valuation approaches
Valuation of share is an important aspect of buy back pricing. A company
should have complete knowledge about the intrinsic value or fair value of
share. Intrinsic value of share is the weighted average of –
− Asset backing value;
− Profit Earning, Capacity Value
− Market value.
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— Buy Back of Shares
A company that cares for its shareholders always comes out to protect the
market price. This is one of the purposes of allowing buy back in India. So one
cannot ignore the asset backing value while pricing buy back.
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— Buy Back of Shares
For deriving Asset backing value the following steps are followed:
• Current costs of assets are determined.
• Value of goodwill is added to total current cost of tangible assets.
• AU liabilities and provisions are deducted.
• Preference share capital is deducted.
• Adequate provision is made against contingent liabilities and deducted
from current cost of assets.
• Net current cost of assets are worked out which represent current cost of
equity.
• Net current cost of assets is divided by number of outstanding equity
shares.
The business is a going concern in the context of buy back. The following
valuation norm may be followed for valuation of assets
• Fixed assets are valued at lower of the current entry price and current exit
price.
• Capital Work-in-progress are yet mature as revenue generating assets, so
they should be valued at cost.
• Quoted investments are valued at market price.
• Unquoted investments are valued at their asset backing value in case
asset-backing value is not available, book value can be used for this
purpose.
• Current assets are valued at lower of the net realizable value and cost.
For comparing cost and market price of inventories item by item
comparison should be carried as required in Accounting Standard-2.
Similarly, for other items of current assets like debtors, loans and
advances item by item comparison should be made. This will make
automatic provisioning of current assets.
• Miscellaneous expenditure and losses should be excluded.
• All liabilities should be taken at the redemption value.
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— Buy Back of Shares
Buybacks are now imminent, but there seems to be lot of confusion as to the
tax implications and the buyback code and regulations. The ministry of
finance has not yet clarified the position, but the likely tax consequences
could be derived from first principles.
We assume that XYZ Ltd's company rate of income tax is 35 per cent and the
capital-gains tax rate is 20 per cent.
But this expense though wholly and exclusively for business would not qualify
as "necessarily" for business.
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— Buy Back of Shares
such losses against other gains. This is far-fetched as XYZ Ltd has not sold
any asset whether fixed or current nor extinguished any liability. Again, it
looks like an equity transaction with the owners, which is distinct from buying
or selling an asset.
Therefore, XYZ Ltd bears the tax burden for distributing its net assets of Rs
15,000 to its owners ABC. This is the treatment adopted worldwide. Thus the
special dividend treatment reflects the substance of a buyback, which is
distribution of excess profits. The buyback code could then require a transfer
of Rs 15,000 from distributable reserves of XYZ Ltd to undistributable
reserves to protect the creditor's buffer and ensure consistency with dividend
treatment.
As to the impact on XYZ Ltd's shareholders, there are two alternatives. ABC
can treat Rs 15,000as capital receipt or dividend receipt. Under section 2 (47)
(ii) of the Income Tax Act, shares are deemed to have been sold if there has
been a change in shareholders' right to vote or right to receive dividend or
right to receive excess capital on liquidation.
In our example, though ABC now owns only 900 shares, ABC can still
exercise the same proportion of votes, that is, 100 per cent and has the right
to receive 100 per cent of XYZ Ltd's dividend.
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— Buy Back of Shares
Here the preference shareholders have lost the right to cast those 100 votes
and the right to receive Rs 15 of annual dividend. Therefore, they will be
deemed to have sold the shares and the net gain of Rs 5,000 will become
taxable (Rs 15,000 proceeds less Rs 10,000 cost). This net gain will be
taxable at the rate of 20 per cent, reducing the net receipt to Rs 14,000. This
capital receipt treatment will be relevant only in such exceptional
circumstances of a buyback.
Thus the accounting principles dictate that companies and shareholders treat
buybacks as a special dividend payment. If buybacks are treated as a
revenue or capital expense, then this would result in significant inconsistency
between Indian business standards and tax practices and those of rest of the
world. More importantly, the revenue or capital treatment would lead to
government tax subsidies on buyback payments made by profitable
companies to their enriched shareholders.
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— Buy Back of Shares
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.
• Public announcement for buy back cannot be made during the pendency
of any scheme of amalgamation or compromise or arrangement. No
purpose can be served by this restriction, in normal Course; a company
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— Buy Back of Shares
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
pendency of lock-in period and until the shares become transferable.
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— Buy Back of Shares
Buyback in India
Internationally, it has been observed that companies have opted for Buyback
in times when they believed that shares were undervalued in the market or
when they had surplus cash in their treasury. E.g. In 1997, Coca-Cola opted
for Buyback of 8.3% of their equity that raised the price of the scrip by a
whopping 42% in the NYSE. Major global companies that have opted for
buyback in the last couple of years include IBM, HP, Washington Post, Nestle,
etc.
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— Buy Back of Shares
The other problem is that most of the Indian companies have a Debt-Equity
ratio greater than one. Buyback would definitely increase this ratio & reduce
the leveraging capacity of the company. This is specially applicable to
companies having a high proportion of fixed assets, like TISCO & TELCO.
Coupled with the fact that the company will not be able to issue new shares
for at least one year, this implies that the company 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, companies are allowed to borrow to buy back their shares in case of a
takeover bid.
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— Buy Back of Shares
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 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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— Buy Back of Shares
The Central Government is reportedly planning to adopt buy back route for
mopping up Rs. 10,000 crore. Reportedly buy back route may be adopted by
big PSUs including Indian Oil Corporation, Bharat Heavy Electricals Ltd., Oil
and Natural Gas Corporation, Bharat Petroleum Corporation Ltd., Gas
Authority of India Ltd. and NALCO.
In view of the prolonged bearish spell in the capital market the Central
Government has failed to achieve targeted disinvestments in the PSU shares.
Buy back route seems to be better than disinvestments because in this the
Central Government can fix the price as per prudential valuation. Reportedly
the core group of secretaries has identified four cash rich oil PSUs, namely,
IOC, BPCL, ONGC and GAIL, for the first trench of buy back. The PSUs have
huge accumulated reserves to satisfy the upper ceiling of buy back. A few
other cash rich PSUs, namely, BHEL and NALCO, might be considered as a
buy back candidate in the second trench.
Under the buy back route the PSUs may launch buy back applying book
building process. In case the quote of the Central Government is lowest it
may be able to sell the desired shares, which it targeted in the disinvestments
route. However, in the buy back route the PSUs have to buy back shares of
ordinary shareholders also on the basis of competitive quote.
In case tender offer route is opted for fixing up a fixed price, the likelihood of
other shareholders participating in the buy back cannot be eliminated.
Reportedly, the buy back may be financed by the financial institutions. This
means IOC, ONGC, BHEL, etc. should swap equity for debt.
Reportedly, the basic telecom service provides MTNL plans to buy back its
share. Present Government holding in MTNL 57.16% is expected to come
down to 54.94 % because of the proposed issue of equity shares to the
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— Buy Back of Shares
Foreign companies
(Rs. Crores)
Company Buy Back Month Amount
Spent
Reckitt Benckiser March 2002 400.0
Cadbury India Ltd. January 2002 874.9
CG Glass Ltd. (Philips) September 2001 13.1
Otis Elevator Co. (I) Ltd. July 2001 109.2
Carrier Aircon Ltd. July 2001 114.8
International Best Foods (HLL) November 2000 24.9
Philips India Ltd. November 2000 234.3
Detergents India Ltd. (Henkel) December 1999 1.1
Indian Companies
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— Buy Back of Shares
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.
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— Buy Back of Shares
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.
9 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
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— Buy Back of Shares
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
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.
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— Buy Back of Shares
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).
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 2001, 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,
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— Buy Back of Shares
though, the same buyback could have been closer to the offer price.
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— Buy Back of Shares
Pitfalls
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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— Buy Back of Shares
Berger Paints
Introduction
The Company also supplies a wide range of products to both the industrial
and the architectural segments. The Company has a number of technology
tie-ups for various high technology paint ranges.
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— Buy Back of Shares
The brief audited financial information of the Company for the last three
financial years and unaudited financial information of the Company for the
nine months ended 31 December, 2004 are given below:
(Rs. In Lakhs)
Particulars Year Year Year Nine
ended ended ended Months
31/03/2002 31/03/2003 31/03/2004 ended
(audited) (audited) (audited) 31/12/2004
(un-
audited)
Key Ratios
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— Buy Back of Shares
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— Buy Back of Shares
Limited (NSE). The Company had not buy-back its equity shares from any
person through negotiated deals whether on or off the Stock Exchange(s)
or through spot transactions or through any private arrangement in the
implementation of the buyback.
6. The maximum amount required by the Company for the said buy-back
aggregating Rs. 1859 lakhs was met out of the free reserves and/or the
share premium account of the Company.
7. The maximum offer price was arrived after taking into consideration
various factors including,, Earning Per Share in the last three years,
Industry average price earning ratio, book value, average of share prices
in the preceding weeks and other relevant factors. The maximum buy-back
price as proposed above will not impair the growth of the Company and
also contribute to the overall enhancement of shareholder value.
8. The number of equity shares bought back would depend upon the average
price paid for the equity shares bought back and the aggregate
consideration paid for such equity shares bought back. As an illustration,
at the proposed maximum offer price of Rs. 60/- per equity share and for
an aggregate consideration amount of Rs.1859 lakhs, the maximum
number of equity shares that can be bought back would be 3098333 equity
shares aggregating approximately 1.56% of the total paid up equity shares
as on 29 April 2005.
9. The aggregate shareholding of the promoters as on 29 April 2005 is
146543273 equity shares constituting 73.53 % of the listed share capital of
the Company.
10. The promoters of the Company have neither purchased nor sold any
shares during the period of six months preceding 29 April, 2005 being the
date of the Board Meeting at which the buy-back was approved except the
following:
9 Share purchased - 1009924 equity shares including inter se
transactions among promoters. The maximum purchase price was Rs.
37.00 on 2 February, 2005 and the minimum purchase price was Rs.
30.75 on 9 November, 2004
9 Shares Sold - 89620 equity shares representing inter se sale among
promoters only. The sale price was Rs. 37.00 on 2 February, 2005.
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— Buy Back of Shares
11. The debt equity ratio of the Company after the buy-back was within the
limit of 2:1 as prescribed under the Companies Act, 1956.
398,561
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— Buy Back of Shares
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— Buy Back of Shares
a. The buy-back was open to all equity shareholders of the Company both
registered and unregistered holding shares either in physical and / or
electronic form, except promoters.
c. For the aforesaid buy-back of equity shares, the Company has appointed
the following registered broker (“Broker to the Offer”) through whom the
purchases and settlement on account of buy-back would be made
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— Buy Back of Shares
The buy-back had caused any material impact on the profitability of the
Company. The buy-back had not impaired the growth of the Company and
also contributes to the overall enhancement of shareholder value.
Post buy-back, the debt equity ratio of the Company will be within the limit of
2:1 as prescribed under the Companies Act.
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— Buy Back of Shares
The Bottomline
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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— Buy Back of Shares
• When there is a small disparity between intrinsic worth of a firm and its
market price, dividends are the preferred distribution mechanism. If the
price disparity is large, a smaller cash outlay on share buyback can
convey the same information as a relatively larger dividend
• Information asymmetry between managers, investors with larger holdings
and small investors means that the smallest distributions should be paid
with dividends, larger distributions should take the form of open market
repurchases and tender offers should be used for the largest distributions.
The yardstick for deciding the size of a signaling buyback is its materiality
level, a number that measures how much impact the buyback will have on the
wealth of shareholders who keep their shares. The materiality level for any
given number of shares the company may buyback depends on the degree to
which the market undervalues the company. But all too many companies
routinely underestimate how many shares they need to buy to send a credible
signal to the markets. While buybacks are typically sized in the 5-10 percent
range, they typically need to be closer to 20 percent to have a material signal.
Buybacks are a more tax efficient form of cash distribution to the firm than
dividends (the firm saves on dividend tax). Furthermore, they create value
through changes in capital structure (the tax shield of debt increases firm
value). However, there are some concerns that need to be addressed in the
currently uncertain economic climate in India. Taxable income in India can be
highly cyclical if the economy continues to nosedive.
Given the current short cooling off period (period in which no fresh issue of
shares is permitted after the buyback) of 6 months, will the change in capital
structure be perceived by the market to be permanent? In the absence of
clear answers, a case for increased valuation due to changes in capital
structure on account of buybacks remain tenuous.
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— Buy Back of Shares
This is probably not in the interest of financial institutions like UTI. Delisting by
multinationals is not in the interest of India’s capital markets. Thus one can
say that buybacks increasingly look less of a boon.
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Bibliography
Websites:
• www.blonnet.com
• www.vckgroup.com
• www.advanishares.com
• www.indiainfoline.com
• www.rediff.com
• www.indiaheadlines.com
• www.indiainfo.com
Newspapers:
• The Times of India
• Business Standard
• Financial Express
• Business Line
Books:
• Buyback of Shares – Ghosh
• Inter – CA module II
• Financial Management- Prasanna Chandra
• Financial Management- Khan & Jain