The Indian market is abuzz with buyback announcements from companies ranging from Quick Heal to Infosys. Currently, more than 40 listed Indian companies are either in the process of announcing buyback plans or have already conducted one.
But before we delve into the reasons why a company conducts a buyback or shareholders capitalize on it, let’s understand what a share buyback is.
What Is A Buyback?
Under Section 68 of the Companies Act 2013, a company can purchase its own shares using its free reserves or money in its securities premium account or from the proceeds of share issues.
The company’s “article of association”, however, must authorise a buyback, and its board must secure shareholders’ consent, with 75 per cent of members in favour, by passing a special resolution.
In the case of Infosys, the company’s board also announced a dividend along with the buyback.
Narendra Solanki, head of equity research at Anand Rathi Shares and Stock Brokers, explains a company pays the shareholders in cash for each share before cancelling them after the buyback plan.
“Shares that have been repurchased are not considered for dividends, voting, or computing earnings per share (EPS),” he added.
Why Does A Company Conduct Buybacks?
● Company’s Stock Price May Get A Boost
Sometimes due to internal or external market factors, stock prices could take a beating, diminishing investors’ confidence.
For example, in 2017, when Infosys Ltd.’s first non-founder CEO Vishal Sikka resigned from the company, its stocks crashed by 13 per cent, trading at a 52-week low of Rs 884.
After such a drastic fall in share price, the Infosys board announced a buyback with a fixed price of Rs 1150 per share, reserving 15 per cent of the offer for small shareholders (holdings up to Rs 2 lakh).
Vinit Bolinjkar, head of research at Ventura Securities, said a buyback helps a company demonstrate its balance sheet strength since only a debt-free company with sufficient cash normally goes for a buyback, sending a “positive sign” to the investors.
So, if a stock is thought to be undervalued or highly discounted by the market, the company may decide to go for a buyback with a good premium from the current market price.
● Buyback Is Tax-Efficient For Indian Shareholders
An Indian listed or unlisted company, post-July 2019, is liable to pay buyback tax plus a surcharge on the differential between the buyback and the issued price. However, investors would not be liable to tax on any gains according to section 10 (34A) of the Income Tax Act, 1961.
Aarti Raote, Partner, Deloitte India, pointed out that if an Indian is a member of a US-listed company (by way of ESOP or LRS investment) and that company conducts a buyback, “the Indian investor would be liable for capital gains tax.”
“For any acquisition of overseas shares by an Indian resident, the FEMA provisions would apply, depending on the type of acquisition made,” Raote added.
So, if an Indian company has cash on its balance sheet and has no project planned in the near future, and wants to return the capital to shareholders, it will be tax-free for investors.
● Buyback Consolidates Company’s Promoter Shareholding Level
Bolinjkar explains that when the company’s promoter doesn’t participate in a buyback, it “reduces the number of outstanding shares and increases the promoter shareholding. The buyback also increases the EPS of a company.”
Thus, it reduces the number of outstanding shares in the market while consolidating shareholders’ ownership. For example, EPS is calculated by dividing the net earnings of a company by its number of outstanding shares.
Assuming company A has a net earning of Rs 1,00,000 and has 1000 outstanding shares, of which the promoters hold 400 shares and the public holds 600 shares, so, EPS will be Rs 100 per share (1,00,000/1000), and the promoter shareholding will be 40 per cent (400/1000*100).
Now, the company goes for a buyback of up to 100 shares, and promoters do not participate in it. So, the outstanding shares will be 1000-100=900 shares, assuming earnings remain the same at Rs 1,00,000, the EPS will be Rs 111.11 per share, and the promoter’s shareholding percentage will be 400/900*100= 44 per cent.
So, the company promoters increased their shareholding in the firm by not participating in it, giving cash to participating shareholders fully tax-free, and increasing its EPS.