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Chapter 1
Introduction To The Indian Capital Market
Sudden plethora…
Chapter 2
Buy back of shares
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.
Buyback Of Shares
Loan
Guarantee
Provision for security or
In any other manner
Chapter 3
SHARE BUY-BACK: OBJECTIVES
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.
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.
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.
With the growth in EPS and a stable Price Earning (PE) multiple,
this will ultimately raise the Price of the stock in the market, since
Stock Price = EPS * PE
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.
Example 1
First, the cost of buyback, that is, the market price of XYZ Ltd's
shares. For example, HLL Ltd, with its cash reserves could do a
buyback but with the current market price hovering around Rs
1,700, this could be expensive.
Chapter 4
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.
Buyback Of Shares
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.
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:
Buyback Conditions:
Chapter 5
Ways of Buyback
2) 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.
Buyback Of Shares
Special Resolution:
1) The buy-back of shares from the open market may be in any one of
the following methods:
Through stock exchange.
Book Building process.
A company can buy back its shares from the existing shareholders on
proportionate basis.
(2) The public announcement shall specify a date, which shall be the
`specified date’ for the purpose of determining the names of the
shareholders to whom the letter of offer shall be sent.
Buyback Of Shares
(3) The specified date shall not be earlier than thirty days and not later
than forty-two days from the date of the public announcement.
(4) The Company shall within seven working days of the public
announcement shall file with the Board a draft-letter of offer containing
disclosures as specified in schedule III through a merchant banker who
is not associated with the company.
(5) The draft letter of offer referred to in sub regulation (4) shall be
accompanied with fees specified in schedule IV.
(6) The letter of offer shall be dispatched not earlier than twenty-one
days from its submission to the Board under sub-regulation (4).
Provided that if, within twenty-one days from the date of submission of
the draft letter of offer, the Board specifies modifications, if any, in the
draft letter of offer, (without being under any obligation to do so) the
merchant banker and the company shall carry out such modifications
before the letter of offer is despatched to the shareholders.
(7) The company shall file along with the draft letter of offer, a
declaration of solvency in the prescribed form and in a manner
prescribed in sub-section (6) of section 77A of the Companies Act .
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.
Buyback Of Shares
(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.
(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.
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).
(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.
(10) The Board in the interest of the shareholders may in case of non-
fulfillment of obligations under the regulations by the company forfeit
the escrow account either in full or in part.
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.
Buyback Of Shares
Chapter 6
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.
Buyback Of Shares
2. The proposed time table from opening of the offer till the
extinguishment of the certificates;
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;
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)
Buyback Of Shares
Buyback Of Shares
Chapter 7
Extinguishment of Certificate
Chapter 8
LEVERAGED BUY BACK
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.
Many strategists like more debt in the capital structure. There are
many reasons for preferring levered capital structure—
Buyback Of Shares
Since equity is costlier to debt, the management may think for buy
back equity through issue of debt instrument. What should be the
precondition of leveraged buy back?
Debt servicing coverage of the company should be good;
Buyback Of Shares
Chapter 9
PRICING BUY BACK
Relevance of pricing
Valuation approaches
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.
For deriving Asset backing value the following steps are followed:
Chapter 10
Tax Implications of Buy Back:
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.
Buyback Of Shares
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.
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.
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.
Chapter 11
General obligations of a company
resorting to buy back
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.
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.
Buyback Of Shares
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.
Chapter 12
Buyback in India
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.
And 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.
Buyback in India
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.
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.
Chapter 13
Recommendations & Findings
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.
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.
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.
on RoE and also assess its future earnings potential before choosing
to stay on as a residual shareholder in it.
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.
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.
Buyback Of Shares
The bottomline.
Chapter 14
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.
Conclusion
Tax motives
A signaling motive or
A takeover deterrent motive.
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.
Chapter 15
Buy Back of PSU's Shares
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.
Buyback Of Shares
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 employees to the extent of 2.22%. So to maintain Government
holding at 51%, the MTNL can buy back about 16.75% of its present
equity share capital.
Buyback Of Shares
Bibliography
Websites:
• www.blonnet.com
• www.vckgroup.com
• www.advanishares.com
• www.indiainfoline.com
• www.google.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
• Financial Management- Prasanna Chandra
Buyback Of Shares
Acknowledgements