Share Buy-Back: Wealth Maximisation Disinvestment a Bonanza for Government | Dhameja & Dhameja

by Nand L. Dhameja and Manish Dhameja*

Share Buy-Back is a simple way to reduce share capital. By this process, the company buys-back its shares and pays from its own cash or by borrowing for the purpose. This enables the company to reduce its capital, extinguishes the extra shares which it does not require; The process is normally followed by companies which are rich in cash, or are in a position to raise funds from the market and it enables it to reduce the capital it does not require, as such, it is a process to cut back extra fat, to get slim and fit. It is done to take advantage of sluggishness in the capital market, when the share prices are having south-end trend and to monopolise by purchasing its own shares and take advantage of the falling capital market.

By share buy-back, the number of shares outstanding get reduced, and the profit gets distributed among reduced number of shares and thus increases EPS. Many consider buy-back as a bullish sign; buy- backs are a two-way street for companies. By reducing the number of shares outstanding, companies can even without profit growth, boost their EPS, that in turn can often drive their share prices higher.

As a recent example, Toyota Motors, Japanese automaker, and world’s No. 1, automaker, plans to buy back shares worth 250 billion yen, ($ 2.5 billion). By this process, the company expects to return to the pre-pandemic profitability of 2.5 trillion yen as compared to 2.4 trillion yen profit for the year 2019 before pandemic.

American companies and banks are ready to reward their shareholders by buying-back their shares. This year the US companies have authorised a $504 billion share buy-back. Companies including Apple inc. ($ 90 billion), and Advance Auto Parts and J P Morgan Chase & Co. ($30 billion) unveiled their plans to buy back their shares (Mint May 17, 2021). Similarly, US industrial conglomerate Johnson Controls International PLC and retailer Kohl’s Corp., have planned share repurchase for the current year.

According to S & P DOW JONES, companies last year spent $519.69 billion on repurchases, down 28.7% from the previous year. Buybacks hit record highs in 2018 and 2019 after the 2017 Tax Cuts and Jobs Act WHICH made it more attractive for companies to repatriate overseas profits. (SOURCE: MARK MAURER, The Wall Street Journal, 28 Apr 2021)

In India, Zerodha Limited, online brokerage firm, plans a buyback scheme worth Rs. 200 crore for its employees. 85% of total employees, i.e., about 800 own about 6-6.5 percent of the shareholding through employee’s stock ownership plan (ESOP), and they will be allowed to sell up to 33% of their holding. The company was converted into a public limited company in 2019. For the year March, 2021, the company recorded revenue of Rs. 1,094 crore. a 15 percent growth over last year; the profit for the year was Rs1000 crore as against Rs 442 crore last year. With the objective to reward its employees, the company plans to give 10 percent of the profit to employees for buy-back; and current year ESOP is expected to push employee’s shareholding to approximately to 8 percent. The company by a special resolution, approved an annual remuneration of up to ₹100 crore each for its founders, Nikhil Kamath, Nikhil Kamath and his spouse Seema Pati; it is only an upper limit for regulatory approval; though the three will get a basic salary of ₹4.17 crore per month each, along with perks and allowances. (Source: HT: May 29,2021, p11)

Similarly, Vedanta Group Chairman Anil Agarwal, metal and mineral billionaire, announced on May 12, 2020, his plan to delist Vedanta Limited Indian unit of Vedanta Resource Limited from BSE and NSE, and to convert it into a private company increasing its shareholding from 50.14 percent by buying 48.94 percent of non-promoters’ shares.
In India, buy-back shares by companies increased during 2020-21 to Rs. 39,295 crore by 61 companies; this was against corresponding figures of Rs. 19,979 crore and Rs. 55,587 crore during the last two years of 2020 and 2019 respectively, respective; number of companies being 52 and 63. The buy-back indicates that either the companies did not have many avenues to deploy the cash or lacked confidence in the business climate in that year.

During 2021 highest buy-back was by Software companies namely TCS and WIPRO for Rs. 16,000 crore and RS. 9,500 crore, respectively. Further, the buy-back during 2021 was by eight PSUs amounting to Rs. 8,910 crore i.e. 23 percent of the total; permitting the government to raise resources by disinvestment.

Buy-back by PSUs reflects disinvestment by the government and is the easiest way to raise resources, in particular, in the period of pandemic as it is a step towards easing of fiscal deficit. Buy-back method was an important method of disinvestment and it accounted for about one-fifth of the total disinvestment realisations in 2013, and during 2015 onward. This route of disinvestment has been adopted by cash-rich PSUs which included BDL, BEL, ACL, MOIL, OIL, EIL, GRSE, MCIL, NALCO, HAL, NPCC, NHPC, CIL, IRCON, NBCC, and we can expect such higher disinvestment during the current period.

As BSE Sensex declined over 32 percent during April-May 2020, and shares of several cash rich companies plunged by up to 50 percent during this period; many companies resorted to financial restructuring of buy-back with an objective to boost shareholder confidence amid the brutal sell-off in the market; such companies included, Sun Pharma, Thomas Cook, Supreme Petrochem, Emami, SP Apparels, Sun Pharmaceuticals (though Thomas Cook later in a rare case got exemption from SEBI for the Share buy-back)

Similarly, promoters of nearly three dozen mid-cap companies bought their own shares in the open market during February 2021, companies included Aditya Birla Capital, Gabriel India, Polyplex Corporation, Motiwal Oswal Financial, Alembic Pharma, Vardhman Textiles and Mastek.

Hindustan Unilever (HUL) adopted buy-back scheme in July 2007 under which equity shares of face value of Re. one was purchased for a price not exceeding Rs. 230 each. The proposal was with the objective to reduce outstanding number of shares and consequently increase EPS and to have an effective use of available cash
Initiative by Sterlite Industries Ltd (SIL) in early 2002 to reduce its share capital and buy-back of shares with the due process of approval from the Bombay High Court and no-objection from the Registrar of Companies (ROC) is a novel example of share purchase. The Scheme envisaged share purchase up to 50 percent (2.79 crore equity shares) of the existing shares. The scheme opened on May 31, 2002, and as per the scheme, the company made an offer to buy the shares at Rs. 150 per equity share, of which Rs. 100 was paid in cash and a debt component of Rs. 50 through non-convertible debenture. The Company mailed cheques worth the holding of individual shareholders to the respective shareholders. The company also enclosed a form, which the shareholder was to fill up, if he or she declined the buy-back. Purchase price of Rs, 150 per equity share represented a 43 % premium to the past six months average market price of Rs 61 per share. The reduction of share capital and buy-back offer was estimated to raise the promoters stake from 43% to 86%. The company termed the proposal to be quite simple and investor friendly, on the other hand it was termed as “controversial for its unconventional procedure”.

Similarly, buy-back scheme by Reliance Industries was adopted twice in the year 2000 and later in the year 2004. For the 2004 scheme, RIL purchases 28.69 lakh shares from the open market valued at Rs. 149.61 crore; and these shares were extinguished from the share capital.

As regards buy-back scheme of 2000 by RIL, it was the largest buy-back scheme at that time, the scheme though for one year got extended for the second year. The buy-back scheme was adopted as a strategy to curb price volatility to build investors’ confidence and to attract long-term investors without buying back a single share. Similar was the scheme adopted by Deepak Fertilizers, Petro Corp (May 2002) and Sirpur Paper Mills (August 2002), as they did not buy even a single share although the market price of shares of these companies was lower than the maximum price for a considerable number of days.

Further, buy-back has been used as a weapon against takeover threat. For example, Great Eastern Shipping Corporation bought back its shares when its sister concern, Gesco faced a takeover threat by the Dalmias’ in early 2001.

As against the above, Cairn India Ltd, a leading oil and gas producer in the country, was found guilty of stock market fraud for its public announcement of share buy-back of 17.8 crore shares of Rs. 10 each (i.e. 8.91 percent of its shareholding) at a maximum price of Rs. 335 from the open market in January 14th, 2014. As per SEBI order, the share buy-back announcement was misleading and was designed to influence the decision of the investors and to induce them to trade in the shares of the company. Cairn Limited which got merged with Vedanta Limited in 2017, and its directors have been asked by the Securities Appellant Tribunal (SAT) to deposit Rs. 2.5 crore by the company and Rs. 15 lakh by each director with SEBI.

In short, buy-back is a scheme which is used by companies as a strategy to restructure their capital structure, to cut back extra fat by extinguishing their shares, to reduce the cash balance to optimal level and to distribute the available profit among reduced number of shares and thus increase EPS which often increases share prices, and thus to reward shareholders Alternatively, the scheme is used by managements as a strategy to increase their shareholding and amass their wealth by taking advantage of falling share prices. Government has used this simple route to finance its fiscal deficit by encashing their shareholding in PSUs.

Ultimately, proper use of buy-back would depend upon, how far it leads to maximisation of wealth of the nation. (26/6/21)

*(Author: Dr. Nand L. Dhameja, Dean & Professor, FMS, Manav Rachna International Institute of Research & Studies, Faridabad, and Manish Dhameja, Senior Banker worked in South Africa, UAE and South Asia)

• Note: Views expressed are of the authors and not the organisations to which they belong