Time and again, you may have heard the term "Buyback".
Simply put, a company buys its own shares from the open market during a buyback.
But why would a company decide to buy its own stock? Is it trying to generate returns?
Well, not exactly. The main outcome of a buyback could be a reduction in the number of shares outstanding for the company.
When a company announces a buyback, many investors wonder whether they should tender their shares or hold on to them for potential future returns.
To make such decisions, it is crucial to understand the objectives behind the share buyback.
Companies might buy back their shares for several reasons. They might aim to increase the promoters' holding or they might conduct a buyback to return surplus cash to shareholders that is if the business does not need it.
By doing so, the company improves its earnings per share (EPS) and return on equity (ROE) since the number of outstanding shares and invested equity capital decrease.
With that explainer out of the way, let us discuss a couple of buybacks that happened in the past, which could shed some light on whether or not to tender your shares during a buyback.
In November 2020, smallcap firm Cosmo Films announced a buyback[1] at a hefty premium.
Cosmo Films agreed to buy back up to 12,67,361 (6.52% of the share base) through the tender offer route.
The buyback price was set at ₹576 per share for ₹730 million, approximately 30% higher than its stock price on the announcement date.
The overall demand scenario improvement was a key factor in why the company opted to take the buyback route and reward shareholders.
The company had just reduced its debt.
Before this, it had launched pet care products in NCR with an initial investment of ₹150-₹180 million.
Within months of this buyback announcement, the company got a lot of traction and started going mainstream.
Over the next year, the company’s stock price surged to record high levels and more than doubled from even the buyback price.
Source: BSE
In such cases, you should return to the basics and check whether the same performance is sustainable. Holding on to the stock makes sense; otherwise, one would be better off tendering.
In October 2016, Mayur Uniquoters came out with a buyback[2] for around 0.5 million shares.
The company fixed the buyback price at ₹500 per share, around a 12% premium to the prevailing market price.
The promoters, too had expressed an intent to participate in the buyback.
When this buyback was announced, the company’s revenues had just declined due to the fall in crude prices and a slowdown in the footwear market.
However, its PU plant was about to get approval soon and was touted as a significant growth driver for the company. The plant was expected to have a revenue potential of ₹2 bn (40% of the consolidated revenues in FY16) and higher margins than the company’s current high-margin PVC products.
The stock continues to trade mostly near the same levels. Only in the current bull run is it looking for a breakout.
Source: BSE
At that time, the risk-reward analysis showed that holding on to Mayur Uniquoters would have made sense as it had big expansion plans. However, it was not a good idea at all. In this case, the upside was also very limited. The market's greed sent the share prices north of the buyback price in the next few months. But it lured several innocent people in the process.
One of India's prominent pharma companies recently came out with a buyback.
Ajanta Pharma’s buyback size[3] was ₹285 crores, and the company offered to buy 10.28 lakh shares through the tender offer.
The price was ₹2,770 per share, around 15% higher than the prevailing market price.
In this buyback, the acceptance percentage for retail investors was very low, in the region of 2% to 6%. If an investor had tendered 1,000 shares for the buyback, there is a strong chance only 20 to 60 shares would have been accepted to be eligible for the scheme.
However, considering the expensive valuations, even at a decent premium of 15%, the offer was hard to ignore.
At the buyback price, the stock would be trading at 40 times its current earnings compared to 27 times that, it has commanded on average over the last 10-year period.
This would have been an absolute no-brainer decision to tender shares in the buyback.
And guess what? After the buyback announcement, the stock price has come down, and trades are way below the buyback price.
Source: BSE
In January 2022, the board of directors of MPS Ltd. passed a resolution and approved a buyback[4] at ₹900 per equity share.
The buyback price of ₹900 per share was at a premium of 27% from the prevailing market price of ₹710.
The promoter and promoter group held 67.99% of the company share capital and expressed their intention to participate in the buyback.
Back then, MPS was coming off a bad quarter and reported flat revenue with declining margins.
However, it had strong growth plans, and the management was confident about revenue and profit growth in the next couple of quarters.
Management aimed for high double-digit margins for its e-learning segment, as the order books and pipeline were at their highest levels in the last two years.
The company's balance sheet showed a healthy cash balance, so all it needed was shareholder confidence, which it got after announcing the buyback at a hefty premium.
Since then, the company and its stock price have been on a growth trajectory.
Source: BSE
This was a classic example of a cash-rich company that did not need any capital investment to generate additional returns and used the excess cash to return it to shareholders.
Let’s take the example of TCS, which has been known to declare multiple buybacks over the years.
In 2017, TCS announced its buyback at ₹1,425, 14% higher than the prevailing price of ₹1,250.
In 2018, TCS offered to buy back shares at ₹2,100 compared to the prevailing market price of ₹1,850, i.e. a premium of 14%
In 2020, TCS announced a buyback at ₹3,000, a 10% premium to the market price.
In 2022, it announced the most lucrative buyback at a 20% premium, ₹4,500, while trading at ₹3,735.
In 2023, the buyback price was set at ₹4,150 per share, a 20% premium over the prevailing market price of ₹3,457.
The IT company has bought back shares worth ₹83,000 crore in the last seven years.
When TCS announced its buyback in 2023, Morgan Stanley published a report[5] examining the share price's performance.
The report mentioned that TCS's stock price took 228 sessions, or nearly a year, to top the buyback price announced in 2017. Following the 2018 buyback, it took 69 sessions for the same; after the 2020 buyback, it took 61 sessions.
This proves that a buyback announcement is no guarantee that the stock will outperform in the following period.
Also, in each buyback case, TCS's stock price gradually increased as its dominant position in the IT industry and management's confidence in its stock indicated a low chance of the stock price falling.
However, seasoned investors know there are no guarantees in the stock market. One has to make presumptions based on their own research and assessment.
Even if a long-term investor had not tendered his shares, he could potentially have gained from the rise in TCS's share price in the next few years.
For those who tender shares, this was a good short-term opportunity to take a well-calculated risk and make a good return on investment.
Several studies show that companies buying back their own shares outperform the market.
Think of a buyback working this way…
Buying out the shareholders during the buyback period does not immediately benefit the company. However, in the next year, the profit will be distributed to fewer shareholders, and each remaining person’s cut will be worth more.
It’s a win-win for both the company and the shareholders. At the end of the day, a buyback offer allows investors to tender a small fraction of the shares owned and even hold on to the rest to cash in on the current opportunity and continue riding the upside over the long run.
Happy Learning!
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Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their own research and consult with financial professionals before making any investment decisions.
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