Buy back of shares

INTRODUCTION TO THE INDIAN CAPITAL MARKET

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.

Financial restructuring involves either internal or external restructuring (i.e. Mergers

and Acquisitions). In the internal restructuring an existing firm undergoes through a series of

changes in terms of composition of assets and liabilities.

Section 100-105 of The Company's Act 1956 governs the internal restructuring of a

corporate entity in the form of capital reduction. Section 77A, 77B and 77AA now allow

companies to buy back their shares following the recommendations of committee on

corporate restructuring, which was set up by the government to propose various strategies to

strengthen the competitiveness of the banking and finance sector, companies are now allowed

to repurchase their own shares.

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.

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 expansion and an inherent ability to outsource

and avail economic costs of production.

In the 1970’s period, if MNC’s wanted to continue doing their business in India, they

could do so only by diluting their shareholding and getting listed on the exchange. They were

thus forced to go public. Now that the norms have been altered and they are permitted to

carry on their business without any such compulsion, they would rather operate as wholly

owned subsidiaries without being listed on the bourses

- 1 -

Buy back of shares

BUY BACK OF SHARES

Buy back of equity shares is a capital restructuring process. It is a financial strategy that

allows a company to buy back its equity shares and other securities. In a changing economic

scenario corporate sector demands more freedom in restructuring debt-equity mix in times of

favorable business environment.

So far it was possible to refund shareholders' money through capital reduction process. A

company could buy back own shares obtaining permission of the Company Law Board under

the old provisions of the Companies Act, 1956. By virtue of the newly inserted section 77A

to the Companies Act, 1956 through the Companies (Amendment) Ordinance, 1999, a new

vista has been opened for flexible capital structuring by companies as and when necessary

without involvement of any external regulatory mechanism.

Buy back is a financial strategy - it should be used accordingly. It is not for improving

controlling interest of the ruling shareholding group. However, improvement of controlling

interest occurs as a natural consequence of buy back strategy.

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.

Creating shareholders' value should be the primary objective of corporate

management. It is difficult to service a large equity and add shareholders' value. Slimming

of capital structure should be an objective of buying back of own shares by companies. Buy

back offers a straight route for swapping equity for debt. In a situation when equity appears

to be costlier to debt, this would help to reduce overall cost of capital.

Prior to introduction of flexible buy back facility; once a particular equity pattern is

opted for it would become sacrosanct. To alter the skewed equity a company has to build up

the level of free reserves or to infuse more borrowed funds. Infusion of more borrowed fund

would be possible in a growth situation.

- 2 -

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. The buying back of outstanding shares (repurchase) by

a company in order to reduce the number of shares on the market. Companies will buyback

shares either to increase the value of shares still available (reducing supply), or to eliminate

any threats by shareholders who may be looking for a controlling stake.

A buyback is a method for company to invest in itself since they can't own

themselves. Thus, buybacks reduce the number of shares outstanding on the market which

increases the proportion of shares the company owns. Buybacks can be carried out in two

ways:

1. Shareholders may be presented with a tender offer whereby they have the option to submit

(or tender) a portion or all of their shares within a certain time frame and at a premium to the

current market price. This premium compensates investors for tendering their shares rather

than holding on to them.

2. Companies buy back shares on the open market over an extended period of time.

- 3 -

Buy back of shares

Restriction that has been lifted

Section 77(l) of the Companies Act, 1956 prohibited (i) a company limited by shares, and (ii)

a company limited by guarantee and having share capital to buy its share.

Section 77(2) of the Companies Act, 1956 disallowed a public company or a private

company, which is a subsidiary of a public company to give any direct or indirect financial

assistance to any person in the form of-

Loan

Guarantee

Provision for security or

In any other manner

for purchase of its own shares or of its holding company.

However, redemption of redeemable preference shares under section 80 of the Companies

Act, 1956 were not subjected to this restriction.

- 4 -

Buy back of shares

Disadvantage of the capital reduction route

Capital reduction is possible for diminution of liability in respect of the unpaid amount of

share capital or payment to any shareholder of any paid-up share capital. If repayment of a

portion of share capital is the purpose; that can be fulfilled through capital reduction.

However, it is not an easy route. It requires an order of court, which in turn requires

fulfillment of the following conditions-

The existing creditors should not object to the capital reduction;

All claims of the creditors who object to the capital reduction should be settled; or

their claims should be provided for;

Contingent or unascertained claims as fixed by the court should be provided for.

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.

- 5 -

Buy back of shares

TERMS RELATED TO BUYBACK OF SHARES

Anti-Dilution Provision:

A provision in an option or a convertible security. It protects an investor from

dilution resulting from later issues of stock at a lower price than the investor

originally paid. Also known as an "anti-dilution clause".

These are common with convertible preferred stock, which is a favored form

of venture capital investment.

Convertible Preferred Stock:

Preferred stock that includes an option for the holder to convert the preferred

shares into a fixed number of common shares, usually anytime after a predetermined

date. Also known as "convertible preferred shares".

Most convertible preferred stock is exchanged at the request of the

shareholder, but sometimes there is a provision that allows the company (or issuer) to

force conversion. The value of convertible common stock is ultimately based on the

performance (or lack thereof) of the common stock.

- 6 -

Buy back of shares

Diluted Earnings Per Share (Diluted EPS):

A performance metric used to gauge the quality of a company's earnings per share (EPS) if

all convertible securities were exercised. Convertible securities refers to all outstanding

convertible preferred shares, convertible debentures, stock options (primarily employee

based) and warrants. Unless the company has no additional potential shares outstanding

(a relatively rare circumstance) the diluted EPS will always be lower than the simple EPS.

Remember that earnings per share is calculated by dividing the company's profit by the

number of shares outstanding. Warrants, stock options, convertible preferred shares, etc. all

serve to increasing the number of shares outstanding. As a shareholder, this is a bad thing. If

the denominator in the equation (shares outstanding) is larger, the earnings per share is

reduced (the same profit figure is used in the numerator). 

This is a conservative metric because it indicates somewhat of a worst-case scenario. On one

hand, everyone holding options, warrants, convertible preferred shares, etc.

is unlikely convert their shares all at once. At the same time, if things go well, there is a good

chance that all options and convertibles will be converted into common stock. A big

difference in a company's EPS and diluted EPS can indicate high potential dilution for the

company's shares, an attribute almost unanimously ostracized by analysts and investors alike.

Venture Capital:

Financing for new businesses. In other words, money provided by investors to startup firms

and small businesses with perceived, long-term growth potential. This is a very important

source of funding for startups that do not have access to capital markets. It typically entails

high risk for the investor, but it has the potential for above-average returns.

Venture capital can also include managerial and technical expertise. Most venture capital

comes from a group of wealthy investors, investment banks and other financial institutions

that pool such investments or partnerships. This form of raising capital is popular among new

companies, or ventures, with limited operating history, who cannot raise funds through a debt

issue. The downside for entrepreneurs is that venture capitalists usually get a say in company

decisions, in addition to a portion of the equity.

- 7 -

Buy back of shares

Book Value Of Equity Per Share (BVPS):

A financial measure that represents a per share assessment of the minimum value of  a

company's equity. More specifically, this value is determined by relating the original value of

a firm's common stock adjusted for any outflow (dividends and stock buybacks) and inflow

(retained earnings) modifiers to the amount of shares outstanding.

Calculated as:

While book value of equity per share is one factor that investors can use to determine whether

a stock is undervalued, this metric should not be used by itself as it only presents a very

limited view of the firm's situation. BVPS provides a snap shot of a firm's current situation,

but considerations of the firm's future are not included. For example, XYZ Corp, a widget

producing company, may have a share price that is currently lower than its BVPS. This may

not indicate that the XYZ is undervalued, because looking ahead, the growth opportunities

for the company are vastly limited as fewer and fewer people are buying widgets.

Book Value:

The value at which an asset is carried on a balance sheet. In other words, the cost of

an asset minus accumulated depreciation. The net asset value of a company, calculated by

total assets minus intangible assets (patents, goodwill) and liabilities. The initial outlay for an

investment. This number may be net or gross of expenses such as trading costs, sales taxes,

service charges and so on. In the U.K., book value is known as "net asset value".

Book value is the accounting value of a firm. It has two main uses:

1. It is the total value of the company's assets that shareholders would theoretically receive if

a company were liquidated.

2. By being compared to the company's market value, the book value can indicate whether a

stock is under- or overpriced.

- 8 -

Buy back of shares

3. In personal finance, the book value of an investment is the price paid for a security or debt

investment. When a stock is sold, the selling price less the book value is the capital gain (or

loss) from the investment.

Dividend:

A distribution of a portion of a company's earnings, decided by the board of directors,

to a class of its shareholders. The dividend is most often quoted in terms of the dollar amount

each share receives (dividends per share). It can also be quoted in terms of a percent of the

current market price, referred to as dividend yield. Mandatory distributions of income and

realized capital gains made to mutual fund investors.

Dividends may be in the form of cash, stock or property. Most secure and stable companies

offer dividends to their stockholders. Their share prices might not move much, but the

dividend attempts to make up for this.High-growth companies rarely offer dividends because

all of their profits are reinvested to help sustain higher-than-average growth. Mutual funds

pay out interest and dividend income received from their portfolio holdings as dividends to

fund shareholders. In addition, realized capital gains from the portfolio's trading activities are

generally paid out (capital gains distribution) as a year-end dividend.

Intrinsic Value:

The actual value of a company or an asset based on an underlying perception of its

true value including all aspects of the business, in terms of both tangible and

intangible factors. This value may or may not be the same as the current market value. Value

investors use a variety of analytical techniques in order to estimate the intrinsic value of

securities in hopes of finding investments where the true value of the investment exceeds its

current market value. For call options, this is the difference between the underlying stock's

price and the strike price. For put options, it is the difference between the strike price and the

underlying stock's price. In the case of both puts and calls, if the respective difference value

is negative, the intrinsic value is given as zero.

For example, value investors that follow fundamental analysis look at both qualitative

(business model, governance, target market factors etc.) and quantitative (ratios, financial

- 9 -

Buy back of shares

statement analysis, etc.) aspects of a business to see if the business is currently out of favor

with the market and is really worth much more than its current valuation.

Intrinsic value in options is the in-the-money portion of the option's premium. For example,

If a call options strike price is $15 and the underlying stock's market price is at $25, then the

intrinsic value of the call option is $10. An option is usually never worth less than what an

option holder can receive if the option is exercised.

Market Value:

The current quoted price at which investors buy or sell a share of common stock or a

bond at a given time. Also known as "market price". The market capitalization plus the

market value of debt. Sometimes referred to as "total market value".

In the context of securities, market value is often different from book value because the

market takes into account future growth potential. Most investors who use fundamental

analysis to pick stocks look at a company's market value and then determine whether or not

the market value is adequate or if it's undervalued in comparison to it's book value, net assets

or some other measure.

- 10 -

Buy back of shares

Tangible Book Value Per Share (TBVPS):

A method of valuing a company, on a per-share basis, by measuring its equity after removing

any intangible assets. The tangible book value per share is calculated as follows:

A company's tangible book value looks at what common shareholders can expect to

receive if the firm went bankrupt and all of its assets were liquidated at their book

value. Intangible assets, such as goodwill, are removed from this calculation, since they

cannot be sold during liquidation. Companies with high tangible book value per share provide

shareholders with more insurance in case of bankruptcy.

Outstanding Shares:

Stock currently held by investors, including restricted shares owned by the company's

officers and insiders, as well as those held by the public. Shares that have been repurchased

by the company are not considered outstanding stock. Also referred to as "issued and

outstanding" if all repurchased shares have been retired.

This number is shown on a company's balance sheet under the heading "Capital

Stock" and is more important than the authorized shares or float. It is used to calculate many

metrics, including market capitalization and earnings per share (EPS).

Share Repurchase:

A program by which a company buys back its own shares from the marketplace, reducing the

number of outstanding shares. This is usually an indication that the company's management

thinks the shares are undervalued.

Because a share repurchase reduces the number of shares outstanding (i.e. supply), it

increases earnings per share and tends to elevate the market value of the remaining shares.

When a company does repurchase shares, it will usually say something along the lines of,

"We find no better investment than our own company."

- 11 -

Buy back of shares

Earnings Per Share (EPS):

The portion of a company's profit allocated to each outstanding share of common stock. EPS

serves as an indicator of a company's profitability.

Calculated as:

In the EPS calculation, it is more accurate to use a weighted-average number of shares

outstanding over the reporting term, because the number of shares outstanding can change

over time. However, data sources sometimes simplify the calculation by using the number of

shares outstanding at the end of the period. Diluted EPS expands on the basic EPS by

including the shares of convertibles or warrants outstanding in the outstanding shares

number.

Earnings per share are generally considered to be the single most important variable in

determining a share's price. It is also a major component of the price-to-earnings valuation

ratio. For example, assume that a company has a net income of $25 million. If the company

paid out $1 million in preferred dividends and had 10 million shares for one half of the year

and 15 million shares for the other half, the EPS would be $1.92 (24/12.5). First, the $1

million is deducted from the net income to get $24 million. Then a weighted average is taken

to find the number of shares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).

An important aspect of EPS that's often ignored is the capital that is required to generate the

earnings (net income) in the calculation. Two companies could generate the same EPS

number, but one could do so with less equity (investment) - that company would be more

efficient at using its capital to generate income and, all other things being equal, would be a

"better" company. Investors also need to be aware of earnings manipulation that will affect

- 12 -

Buy back of shares

the quality of the earnings number. It is important not to rely on any one financial measure,

but to use it in conjunction with statement analysis and other measures.

Return On Equity (ROE):

A measure of a corporation's profitability that reveals how much profit a company

generates with the money shareholders have invested.  

Calculated as:

 

Also known as "return on net worth (RONW)".

The ROE is useful for comparing the profitability of a company to that of other firms in the

same industry.There are several variations on the formula that investors may use:

1. Investors wishing to see the return on common equity may modify the formula above by

subtracting preferred dividends from net income and subtracting preferred equity from

shareholders' equity, giving the following: return on common equity (ROCE) = net income -

preferred dividends/common equity.

2. Return on equity may also be calculated by dividing net income by average shareholders'

equity. Average shareholders' equity is calculated by adding the shareholders' equity at the

beginning of a period to the shareholders' equity at period's end and dividing the result by

two.

3. Investors may also calculate the change in ROE for a period by first using the shareholders'

equity figure from the beginning of a period as a denominator to determine the

beginning ROE. Then, the end-of-period shareholders' equity can be used as the

denominator to determine the ending ROE. Calculating both beginning and ending ROEs

allows an investor to determine the change in profitability over the period.

- 13 -

Buy back of shares

Price-Earnings Ratio (P/E Ratio):

A valuation ratio of a company's current share price compared to its per-share earnings.

Calculated as:

 

For example, if a company is currently trading at $43 a share and earnings over the last 12

months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95). EPS is

usually from the last four quarters (trailing P/E), but sometimes it can be taken from the

estimates of earnings expected in the next four quarters (projected or forward P/E). A third

variation uses the sum of the last two actual quarters and the estimates of the next two

quarters. Also sometimes known as "price multiple" or "earnings multiple". 

In general, a high P/E suggests that investors are expecting higher earnings growth in the

future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the

whole story by itself. It's usually more useful to compare the P/E ratios of one company to

other companies in the same industry, to the market in general or against the company's own

historical P/E. It would not be useful for investors using the P/E ratio as a basis for their

investment to compare the P/E of a technology company (high P/E) to a utility company (low

P/E) as each industry has much different growth prospects. The P/E is sometimes referred to

as the "multiple", because it shows how much investors are willing to pay per dollar of

earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is

that an investor is willing to pay $20 for $1 of  current earnings. It is important that investors

note an important problem that arises with the P/E measure, and to avoid basing a decision on

this measure alone. The denominator (earnings) is based on an accounting measure of

earnings that is susceptible to forms of manipulation, making the quality of the P/E only as

good as the quality of the underlying earnings number.

- 14 -

Buy back of shares

Price-To-Book Ratio (P/B Ratio):

A ratio used to compare a stock's market value to its book value. It is calculated by dividing

the current closing price of the stock by the latest quarter's book value per share. Also known

as the "price-equity ratio".

Calculated as:

A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that

something is fundamentally wrong with the company. As with most ratios, be aware this

varies  by industry. This ratio also gives some idea of whether you're paying too much for

what would be left if the company went bankrupt immediately.

Price/Earnings To Growth (PEG Ratio):

A ratio used to determine a stock's value while taking into account earnings growth. The

calculation is as follows:

PEG is a widely used indicator of a stock's potential value. It is favored by many over

the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower

PEG means that the stock is more undervalued. Keep in mind that the numbers used are

projected and, therefore, can be less accurate. Also, there are many variations using earnings

from different time periods (i.e. one year vs five year). Be sure to know the exact definition

your source is using.

- 15 -

Buy back of shares

Trailing Price-To-Earnings (Trailing P/E):

The sum of a company's price-to-earnings, calculated by taking the current stock price and

dividing it by the trailing earnings per share for the past 12 months. This measure differs

from forward P/E, which uses earnings estimates for the next four quarters. The trailing P/E

ratio is calculated as follows:

This is the most commonly used P/E measure because it is based on actual earnings and,

therefore, is the most accurate. However, stock prices are constantly moving while earnings

remain fixed. As a result, forward P/E can sometimes be more relevant to investors when

evaluating a company.

Price/Earnings to Growth and Dividend Yield (PEGY Ratio):

A variation of the price-to-earnings ratio where a stock's value is further evaluated by its

projected earnings growth rate and dividend yield. 

Calculated as:

For stocks that pay a substantial dividend, the PEGY may be an even better measure than

PEG. As with the PEG, keep in mind the numbers are based on future projections and

therefore, aren't guaranteed to be accurate. PEGY is pronounced the same way as "peggy."

- 16 -

Buy back of shares

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.

- 17 -

Buy back of shares

Securities premium Account

Securities Premium Account is a broader term than Share Premium Account. Share Premium

account represents only premium on issue of equity and preference shares, whereas securities

premium account represents premium on issue of debentures, bonds and other financial

instruments.

Proceeds of an earlier issue

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.

That apart buy back of shares is allowed utilizing proceeds of an earlier issue. Proceeds of an

earlier issue is an unqualified term. Any issue means any issue of hybrid instruments,

debentures, bonds, secured and unsecured loans etc. Thus buy back of equity shares is

allowed byissue of any pure or hybrid debt instruments.

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.

- 18 -

Buy back of shares

Buy Back sourcing caution

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:

How much of the free reserve and securities premium account are readily available in

the form of free cash?

Whether owned investments in current assets are released for buy back? If so, its

impact on current ratio?

Whether non-trade investments will be disposed to generate free cash? If yes, what is

the possible profit/loss?

If trade investments are proposed to be sold, what is the possible adverse impact on

operating activities?

If any fixed assets are sold, whether it has been intended to reduce the scale of

operation of the company

- 19 -

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.

- 20 -

Buy back of shares

PUBLIC ANNOUNCEMENTS

Public announcement is an important communication to the shareholders detailing out the

buy back. Although buy back is approved by special resolution in the general meeting, it is

expected that shareholders are aware of the buy back proposal of the company through

explanatory statement attached to the notice of the meeting, but there is no requirement to

ensure that the resolution should be informed to the shareholders.

Thus public announcement is the formal communication about the approved buy back

proposal of the company. It has been discussed in Chapter Three that as per SEBI

Regulations a company should not withdraw from buy back offer once public announcement

is made or draft offer letter is filed with the SEBI.

In case of tender offer, public announcement precedes submission of draft offer letter to the

SEBI. Draft offer letter is required to be submitted within seven days from date of public

announcement. The same course should be followed in case of buy back of odd lots. In case

of buy back through stock exchange operation, copy of the public announcement is submitted

to the SEBI and it should be made at least seven days prior to the buy back.

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.

Information content of the public announcement provides advance information to the

shareholders about the buyback. This information is also incorporated in the draft offer letter.

- 21 -

Buy back of shares

Disclosures To Be Made In The Letter Of Offer

The letter of offer shall, inter-alia, contain the following:

1. Details of the offer including the total number and percentage of the total paid up

capital and free reserves proposed to be bought back and price;

2. The proposed time table from opening of the offer till the extinguishment of the

certificates;

3. Authority for the offer of buy-back;

4. A full and complete disclosure of all material facts including the contents of the

explanatory statement annexed to the notice for the general meeting at which the

special resolution approving the buy back was passed;

5. The necessity for the buy back;

6. The process to be adopted for the buy back;

7. The minimum and the maximum number of securities that the company proposes to

buy-back, sources of funds from which the buy-back would be made and the cost of

financing the buy-back;

8. Brief information about the company;

9. Audited Financial information for the last 3 years and the company and its Directors

shall ensure that the particulars (audited statement and un-audited statement)

contained therein shall not be more than 6 months old from the date of the offer

document together with financial ratios as may be specified by the Central

Government ( as per the amendment effective from March 2000 ) ;

10. Present capital structure (including the number of fully paid and partly paid securities)

and shareholding pattern;

- 22 -

Buy back of shares

11. The capital structure including details of outstanding convertible instruments, if any,

post buy-back;

12. The aggregate shareholding of the promoter group and of the directors of the

promoters, where the promoter is a company and of persons who are in control of the

company;

13. The aggregate number of equity shares purchased or sold by persons mentioned in

clause (xii) above during a period of twelve months preceding the date of the public

announcement and from the date of public announcement to the date of the letter of

offer; the maximum and minimum price at which purchases and sales referred to

above were made alongwith the relevant date;

14. Management discussion and analysis on the likely impact of buy back on the

company's earnings, public holdings, holdings of Non Resident Indians/Foreign

Institutional Investors, etc., promoters holdings and any change in management

structure;

15. The details of statutory approvals obtained;

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;

ii. A declaration to be signed by at least two whole time directors, one of

whom shall be the managing director stating that the Board of Directors has made

a full enquiry into the affairs and prospectus of the company and that they have

formed the opinion-

a. As regards its prospects for the year immediately following the

date of the letter of offer that, having regard to their intentions with respect to the

- 23 -

Buy back of shares

management of the company's business during the year and to the amount and

character of the financial resources which will in their view be available to the

company during that year, the company will be able to meet its liabilities and will

not be rendered insolvent within a period of one year from the date;

b. In forming their opinion for the above purposes, the directors shall take into

account the liabilities as if the company were being wound up under the

provisions of the Companies Act, 1956 (including prospective and contingent

liabilities)

17. The declaration must in addition have annexed to it a report addressed to the directors

by the company's auditors stating that-

a. They have inquired into the company's state of affairs, and

b. The amount of permissible capital payment for the securities in question is in

their view properly determined; and

c. They are not aware of anything to indicate that the opinion expressed by the

directors in the declaration as to any of the matters mentioned in the declaration is

unreasonable in all the circumstances.

18. Such other disclosures as may be prescribed by the Central Government from time to

time.

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)

- 24 -

Buy back of shares

- 25 -

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 dematerialised 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,.

- 26 -

Buy back of shares

SHARE BUY-BACK: OBJECTIVES

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 preference share

capital.

- 27 -

Buy back of shares

To thwart the attempts of a hostile takeover. The maximum limit of shares that a

company can buy back in a financial year is 25% of the total equity and the fund exposure

is limited to 25% of the net worth or 100% of the free reserves, whichever is more.

Pricing for buyback has been left to the discretion of the company.

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 :

Promoters30%

FIs25%

Public45%

Promoters

FIs

Public

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.

- 28 -

Buy back of shares

BUYBACK OF SHARES UNDER INDIAN COMPANIES ACT

1956

The provisions regulating buy back of shares are contained in Section 77A, 77AA and

77B of the Companies Act,1956. These were inserted by the Companies (Amendment)

Act,1999. The Securities and Exchange Board of India (SEBI) framed the SEBI(Buy Back of

Securities) Regulations,1998 and the Department of Company Affairs framed the Private

Limited Company and Unlisted Public company (Buy Back of Securities) Regulations,1998

pursuant to Section 77A(2)(f) and (g) respectively.

Objectives of Buy Back:

Shares may be bought back by the company on account of one or more of the following

reasons:

To increase promoters holding.

Increase earning per share.

Rationalize the capital structure by writing off capital not represented by available

assets.

Support share value.

To thwart takeover bid.

To pay surplus cash not required by business.

Resources of Buy Back:

A Company can purchase its own shares from 

(i) free reserves; Where a company purchases its own shares out of free reserves, then a sum

equal to the nominal value of the share so purchased shall be transferred to the capital

redemption reserve and details of such transfer shall be disclosed in the balance-sheet or

(ii) securities premium account; or 

- 29 -

Buy back of shares

(iii) proceeds of any shares or other specified securities. A Company cannot buyback its

shares or other specified securities out of the proceeds of an earlier issue of the same kind of

shares or specified securities.

Conditions of Buy Back:

(A) The buy-back is authorised by the Articles of association of the Company;

(B) A special resolution has been passed in the general meeting of the company authorising

the buy-back. In the case of a listed company, this approval is required by means of a postal

ballot. Also, the shares for buy back should be free from lock in period/non

transferability.The buy back can be made by a Board resolution If the quantity of buyback is

or less than ten percent of the paid up capital and free reserves;

(C) The buy-back is of less than twenty-five per cent of the total paid-up capital and fee

reserves of the company and that the buy-back of equity shares in any financial year shall not

exceed twenty-five per cent of its total paid-up equity capital in that financial year;

(D) The ratio of the debt owed by the company is not more than twice the capital and its free

reserves after such buy-back;

(E) There has been no default in any of the following

i. in repayment of deposit or interest payable thereon,

ii. redemption of debentures, or preference shares or

iii. payment of dividend, if declared, to all shareholders within the stipulated time of 30 days

from the date of declaration of dividend or

iv. repayment of any term loan or interest payable thereon to any financial institution or bank;

(F) There has been no default in complying with the provisions of filing of Annual Return,

Payment of Dividend, and form and contents of Annual Accounts;

(G) All the shares or other specified securities for buy-back are fully paid-up;

- 30 -

Buy back of shares

(H) The buy-back of the shares or other specified securities listed on any recognised stock

exchange shall be in accordance with the regulations made by the Securities and Exchange

Board of India in this behalf; and

(I) The buy-back in respect of shares or other specified securities of private and closely held

companies is in accordance with the guidelines as may be prescribed.

Disclosures in the explanatory statement:

The notice of the meeting at which special resolution is proposed to be passed shall be

accompanied by an explanatory statement stating – 

I. A full and complete disclosure of all material facts.

II. The necessity for the buy-back.

III. The class of security intended to be purchased under the buy-back.

IV. The amount to be invested under the buy-back.

V. The time-limit for completion of buy-back.

 

Sources from where the shares will be purchased:

The securities can be bought back from

 

(A) Existing security-holders on a proportionate basis;

Buyback of shares may be made by a tender offer through a letter of offer from the holders of

shares of the company or 

(B) The open market through

(i) Book building process;

(ii) Stock exchanges or

(C) Odd lots, that is to say, where the lot of securities of a public company, whose shares are

listed on a recognized stock exchange, is smaller than such marketable lot, as may be

specified by the stock exchange; or

(D) purchasing the securities issued to employees of the company pursuant to a scheme of

stock option or sweat equity.

- 31 -

Buy back of shares

Filing of Declaration of solvency:

After the passing of resolution but before making buy-back, file with the Registrar and the

Securities and Exchange Board of India a declaration of solvency in form 4A. The

declaration must be verified by an affidavit to the effect that the Board has made a full

inquiry into the affairs of the company as a result of which they have formed an opinion that

it is capable of meeting its liabilities and will not be rendered insolvent within a period of one

year of the date of declaration adopted by the Board, and signed by at least two directors of

the company, one of whom shall be the managing director, if any: No declaration of solvency

shall be filed with the Securities and Exchange Board of India by a company whose shares

are not listed on any recognized stock exchange.

- 32 -

Buy back of shares

Register of securities bought back :

After completion of buyback, a company shall maintain a register of the securities/shares so

bought and enter therein the following particulars:

A. The consideration paid for the securities bought-back,

B. The date of cancellation of securities,

C. The date of extinguishing and physically destroying of securities,

Such other particulars as may be prescribed,

Where a company buys-back its own securities, it shall extinguish and physically destroy the

securities so bought-back within seven days of the last date of completion of buy-back.

Issue of further shares after Buy back:

Every buy-back shall be completed within twelve months from the date of passing the special

resolution or Board resolution as the case may be. A company which has bought back any

security cannot make any issue of the same kind of securities in any manner whether by way

of public issue, rights issue up to six months from the date of completion of buyback.

Filing of return with the Regulator:

A Company shall, after the completion of the buy-back file with the Registrar and the

Securities and Exchange Board of India, a return in form 4 C containing such particulars

relating to the buy-back within thirty days of such completion. No return shall be filed with

the Securities and Exchange Board of India by an unlisted company.

Prohibition of Buy Back:

A company shall not directly or indirectly purchase its own shares or other specified

securities –

(A) Through any subsidiary company including its own subsidiary companies; or 

(B) Through any investment company or group of investment companies;

- 33 -

Buy back of shares

Procedure for buy back:

A. Where a company proposes to buy back its shares, it shall, after passing of the

special/Board resolution make a public announcement at least one English National Daily,

one Hindi National daily and Regional Language Daily at the place where the registered

office of the company is situated.

B. The public announcement shall specify a date, which shall be "specified date" for the

purpose of determining the names of shareholders to whom the letter of offer has to be sent.

C. A public notice shall be given containing disclosures as specified in Schedule I of the

SEBI regulations.

D. A draft letter of offer shall be filed with SEBI through a merchant Banker. The letter of

offer shall then be dispatched to the members of the company.

E. A copy of the Board resolution authorising the buy back shall be filed with the SEBI and

stock exchanges.

F. The date of opening of the offer shall not be earlier than seven days or later than 30 days

after the specified date.

G. The buy back offer shall remain open for a period of not less than 15 days and not more

than 30 days.

H. A company opting for buy back through the public offer or tender offer shall open an

escrow Account.

- 34 -

Buy back of shares

Penalty:

If a company makes default in complying with the provisions the company or any officer of

the company who is in default shall be punishable with imprisonment for a term which may

extend to two years, or with fine which may extend to fifty thousand rupees, or with both.

The offences are, of course compoundable under Section 621A of the Companies Act, 1956.

- 35 -

Buy back of shares

RECOMMENDATIONS & FINDINGS

What should you look at before participating in buybacks?

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.

Debt-equity ratio is an important criterion. The companies having high debt

burden are unlikely to have free cash. They should prefer redeeming their debt first, to

buying back equity. MNCs having subsidiaries in India are unlikely to have any motive of

rigging up the share price and their buyback offer is likely to be genuine.

Track record of raising capital in the past. Companies that have frequented the

capital markets to raise money are unlikely to be good candidates for buyback.

Look at ROCE/RONW-The companies with consistently high ROCE/RONW

are more likely to have free cash than others.

Checkout the previous price pattern of the share Companies generally

tend to buyback shares at a higher premium over the market price if they feel that their

shares are under-priced. This decision to buyback often leads to an increase in share price.

At this stage, you have to analyse the fluctuation in the price of the scrip for a specific

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.

- 36 -

Buy back of shares

Take note of Irrationality A buyback offer with a huge premium may appear

very attractive. Investigate and ensure that any temporary negatives do not affect the

share price. If you feel that the share prices of the company are presently undervalued,

refrain from selling, since a company buying back its shares is indirectly conveying that

its shares are undervalued.

Take a long-term perspective It would be difficult to envisage whether a

company would issue bonus or split shares or make an acquisition. But these factors can

be sidelined if the fundamentals of the company are strong and you expect the company

to perform well in the future. Therefore, in the long-term perspective, the scripts of such

companies should not be sold.

Dispose off volatile shares Despite strong fundamentals, the shares of a few

companies are highly volatile and exhibit wild oscillation in prices. If you want to play it

safe and avoid volatility, selling out would be a better option.

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.

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.

- 37 -

Buy back of shares

Caution is advised in the following types of companies:

Where the management talks about buyback, as market has not valued their

shares fully. To my mind, a good management will never bother about its share price and

valuation as done by the market. It would know that if it continues to perform well, the

market has to take notice in the long term.

Where the management has passed, with a lot of publicity, special resolutions

empowering the Board to buy back whenever allowed. Anybody with the genuine

intention of buying back to enhance shareholders' wealth would try to do so with

minimum publicity so that the share price does not flare up.

Buyback has no impact on the fundamentals of the economy or companies. Investors should

be cautious of unscrupulous promoters' traps.

To sell or not to sell?

When confronted with a buyback offer, one shouldn’t just be guided by the offer price in

relation to the prevailing market price. Yes, if you were looking to exit the stock anyway,

that’s perhaps all you need to look at. However, if you are a medium- to long-term investor in

the company, you also need to weigh the implications of the buyback on the company and its

stock–and, therefore, your investment.

Earnings per share (EPS).

Post-buyback, the EPS of a company is bound to increase due to a reduction in equity.

However, going forward, the EPS could fall if the performance of the company

deteriorates, or if the funds used for the buyback earned significant additional income for

the company.

Hence, future prospects of the company ought to be your biggest consideration while

evaluating its buyback offer. If the company is expected to record healthy growth, it pays

to stay invested in it. However, if it is expected to founder, exiting might be a better

- 38 -

Buy back of shares

option. This fact is borne out by the contrasting post-buyback numbers of two companies

that have bought back stock in recent times, Bajaj Auto and GE Shipping .

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.

Return on equity (RoE).

Post-buyback, the net worth the company must service decreases. Even if the company

does not expand its bottom line considerably, this would result in an improved RoE for

residual shareholders.

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).

- 39 -

Buy back of shares

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 this year, 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, though, the same buyback could have been closer to

the offer price.

However, when a company makes a buyback with the prime intention to increase its

promoters’ stake, it’s dipping into its net worth without necessarily meaning to increase

shareholder wealth. Therefore, you need to evaluate the impact the outflow of funds would

have on the company’s operations and whether this could be detrimental to future growth.

- 40 -

Buy back of shares

Price and liquidity.

A buyback rouses interest in a scrip. When done through open market purchases, it

creates a cap or floor for the stock. In a bullish market, the buyback price creates a floor

for the scrip in the secondary market. When Reliance offered to buy back its shares in

June 2000 at Rs 303 per share, this effectively became the floor price for the stock. The

stock traded below that level for just 11 days over the next 264 trading days, as market

players anticipated that Reliance would step in and make purchases if it dipped below Rs

303.

In a bearish market, though, this is reversed–the maximum buyback price becomes a

ceiling price for the scrip. Reliance never did pick any stock till June 2001 (when the

initial buyback approval lapsed). It took fresh approval, on the same terms. Post-

September 11, the scrip hasn’t breached Rs 303. In this bearish market, investors are not

inclined to pay more than what the management perceives to be a fair value for the stock.

A buyback has greater implications for investors in illiquid stocks, as it offers them a much-

needed exit route. However, post-buyback, liquidity in such stocks is likely to decline further

due to a drop in their free float. It’s not a good idea to hold an illiquid stock–low liquidity

results in poor price determination. In extreme cases, where a 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.

- 41 -

Buy back of shares

The bottomline.

Buybacks should be used as an opportunity to exit only when there is concern over a

company’s prospects or when the post-buyback free float is expected to shrink considerably.

In most other cases, buybacks do offer the lure of an immediate benefit–but you might be

better off as a residual shareholder, and gain from a hike in the share of assets and profits of

the business.

- 42 -

Buy back of shares

General obligations of a company resorting to buy back

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.

- 43 -

Buy back of shares

Public announcement for buy back cannot be made during the tendency of any

scheme of amalgamation or compromise or arrangement. No purpose can be served by

this restriction, in normal Course; a company 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 tendency of

lock-in period and until the shares become transferable.

Publication of buy back information:

The company is required to make public announcement by way of

advertisement in a national daily within two days from the date of completion of the

buyback inter alias disclosing:

Number of shares bought back;

Price at which shares are bought back;

Total amount invested in the buy back;

Details of the shareholders from whom more than 1% of the shares are bought back;

Consequential changes in the capital structure and shareholding pattern before and after

buy back.

- 44 -

Buy back of shares

WHY COMPANIES BUYBACK THE SHARES?

Unused Cash: If they have huge cash reserves with not many new profitable

projects to invest in and if the company thinks the market price of its share is

undervalued. Eg. Bajaj Auto went on a massive buy back in 2000 and Reliance's

recent buyback. However, companies in emerging markets like India have growth

opportunities. Therefore applying this argument to these companies is not logical.

This argument is valid for MNCs, which already have adequate R&D budget and

presence across markets. Since their incremental growth potential limited, they can

buyback shares as a reward for their shareholders.

* Tax Gains Since dividends are taxed at higher rate than capital gains companies prefer

buyback to reward their investors instead of distributing cash dividends, as capital gains tax is

generally lower. At present, short-term capital gains are taxed at 10% and long-term capital

gains are not taxed.

* Market perception By buying their shares at a price higher than prevailing market

price company signals that its share valuation should be higher. Eg: In October 1987 stock

prices in US started crashing. Expecting further fall many companies like Citigroup, IBM et

al have come out with buyback offers worth billions of dollars at prices higher than the

prevailing rates thus stemming the fall.

Recently the prices of RIL and REL have not fallen, as expected, despite the spat between the

promoters. This is mainly attributed to the buyback offer made at higher prices.

* Exit option If a company wants to exit a particular country or wants to close the

company.

* Escape monitoring of accounts and legal controls If a company wants to avoid

the regulations of the market regulator by delisting. They avoid any public scrutiny of its

books of accounts.

- 45 -

Buy back of shares

Show rosier financials Companies try to use buyback method to show better

financial ratios. For eg. When a company uses its cash to buy stock, it reduces

outstanding shares and also the assets on the balance sheet (because cash is an asset).

Thus, return on assets (ROA) actually increases with reduction in assets, and return on

equity (ROE) increases as there is less outstanding equity. If the company earnings

are identical before and after the buyback earnings per share (EPS) and the P/E ratio

would look better even though earnings did not improve. Since investors carefully

scrutinize only EPS and P/E figures, an improvement could jump-start the stock. For

this strategy to work in the long term, the stock should truly be undervalued.

* Increase promoter's stake Some companies buyback stock to contain the dilution in

promoter holding, EPS and reduction in prices arising out of the exercise of ESOPs issued to

employees. Any such exercising leads to increase in outstanding shares and to drop in prices.

This also gives scope to takeover bids as the share of promoters dilutes. Eg. Technology

companies which have issued ESOPs during dot-com boom in 2000-01 have to buyback after

exercise of the same. However the logic of buying back stock to protect from hostile

takeovers seem not logical. It may be noted that one of the risks of public listing is

welcoming hostile takeovers. This is one method of market disciplining the management.

Though this type of buyback is touted as protecting over-all interests of the shareholders, it is

true only when management is considered as efficient and working in the interests of the

shareholders

.

* Generally the intention is mix of any of the above

* Sometimes Governments nationalize the companies by taking over it and then compensates

the shareholders by buying back their shares at a predetermined price. Eg. Reserve Bank of

India in 1949 by buying back the shares.

- 46 -

Buy back of shares

WHAT ARE THE METHODS IN WHICH BUYBACK CAN

HAPPEN?

Share buyback can take place in 3 ways:

1. Shareholders are presented with a tender offer where they have the option to submit a

portion of or all of their shares within a certain time period and at usually a price higher than

the current market value. Another variety of this is Dutch auction, in which companies state

a range of prices at which it's willing to buy and accepts the bids. It buys at the lowest price at

which it can buy the desired number of shares.

2. Through book-building process.

3. Companies can buy shares on the open market over a long-term period subject to

various regulator guidelines like SEBI.

In both 1 & 2 promoters can participate in buyback and not in 3.

- 47 -

Buy back of shares

RESTRICTIONS ON BUYBACK BY INDIAN COMPANIES

Some of the features in government regulation for buyback of shares are:

(1) A special resolution has to be passed in general meeting of the shareholders.

(2) Buyback should not exceed 25% of the total paid-up capital and free reserves.

(3) A declaration of solvency has to be filed with SEBI and Registrar Of Companies.

(4) The shares bought back should be extinguished and physically destroyed.

The company should not make any further issue of securities within 2 years, except bonus,

conversion of warrants, etc.

These restrictions were imposed to restrict the companies from using the stock markets as

short term money provider apart from protecting interests of small investors.

- 48 -

Buy back of shares

VALUATION OF BUYBACK

There are two ways companies determine the buyback price. They use the average closing

price (which is a weighted average for volume) for a period immediately before to the

buyback announcement. Based on the trend and value a buyback price is decided.

In the 2nd, shareholders are invited to sell some or all of their shares within a set price range.

The low point of the range is at a discount to the market price, while the top of the price

range is set at a premium to the market price. Investors are given more say in the buyback

price than in the above arrangement. Still this method is rarely used. Generally, the price is

fixed at a mark up over and above the average price of the last 12-18 months.

Any manipulations?

* Some companies come out with a scheme of buyback wherein, unless the shareholders

rejected the offer specifically, in response to the offer letter sent by the company, they would

be deemed to have accepted it. Though courts have upheld the action of the companies, it is

to be noted that small shareholders generally do not bother to read such letters and respond to

the same, and may not understand the complex legal language used in such letters.

* Some companies make it compulsory for shareholders to sell at a specified price mandated

by the company. A shareholder enters a company by choice and mutual agreement and

should be entitled to exit only by choice. Forcible buyback of shares at a non-transparent

price would be expropriation and should be prevented. Note: GoI's budget of FY 2002-03 has

relaxed buyback rules for the companies by which buyback of shares up to 10% of paid-up

capital does not require shareholders approval thus putting the minority shareholders at the

mercy of majority shareholders and promoters.

Eg. MNCs listed on exchanges have taken this route in a big way in 2001-2003.

- 49 -

Buy back of shares

CHECKLIST OF INVESTORS BEFORE ACCEPTING THE

BUYBACK OFFER

* Take a look at the share price movement immediately before the buyback. If there was a

significant rise, the prima facie assumption is that the promoters have been up to tricks.

* Debt-equity ratio: The companies aare hugely under debts are unlikely to have free cash.

* Companies that have just come to the capital markets to raise money are unlikely to be

good candidates for buyback.

* When the management has passed special resolutions, with a lot of publicity, empowering

the Board to buy back whenever allowed, there is enough scope for suspicion. Anybody with

the genuine intention of buying back to enhance shareholders' wealth would try to do so with

minimum publicity so that the share price does not flare up due to speculators.

- 50 -

Buy back of shares

EFFECT OF BUYBACK ON STOCK EXCHANGE

Buyback may leads to abnormal increase of prices posing heavy risk to those who

value shares based on fundamentals. This may also lead to reduction in investor interest in the

market particularly with de-listing of good shares. Eg: It was feared in 2001-03 that de-listing

by many MNCs may drop the money flow to stock exchanges.

BUYBACK IN INDIA

In India the Buyback clause comes with certain clauses.

The main objective of these clauses is to prevent Promoters from malpractice. For

example with Buyback a co. might be able to improve its EPS & improve the Market value of

the scrip (assuming at constant P/E) & thereafter come up with an IPO at a higher premium to

shore up the Share Premium Account.

A promoter might be able to corner a substantial number of shares through open market

purchases (not triggering the Takeover code, however) & force the company to buy back

these shares at a higher price, making a clean profit in the process. To prevent such

malpractice the Working Group has recommended the following:

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.

Only Free Reserves are allowed to be utilized for the purpose of Buyback. It has been

argued hotly that a company will be rewarding the shareholders through a Buyback route as

well as it does through Bonus & Rights issue, Dividends, etc. If a company buys back the

shares and extinguishes them, its Equity decreases to that extent, thereby increasing its EPS.

- 51 -

Buy back of shares

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.

- 52 -

Buy back of shares

BUYBACK IN INDIA:

In India though many specified group cos. qualify for Buyback, at current prices, not

many of them will be able to utilize their cash flow to buy back their shares, as it will directly

affect their cash requirements for normal operations. Cash rich cos. like Reliance 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.

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, cos. are allowed to

borrow to buy back their shares in case of a takeover bid.

However in India a co. is not allowed to undertake fresh borrowings for the purpose

of Buyback. This means that weaker cos. which are inevitably takeover targets cannot resort

to Buyback as a defense mechanism.

The lacunae in the buyback guidelines need to be addressed like the applicability of

SEBI’s takeover code. A company buying back to a certain percentage, will it necessarily

have to comply with the SEBI Takeover Code regulations. For, on dilution, the proportion of

shares held by the promoters would increase and set off a trigger under Regulation 10 of the

SEBI Takeover Code.

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

- 53 -

Buy back of shares

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.

- 54 -

Buy back of shares

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.

The utilization of a company’s cash reserve to fund it’s re purchase plans, if viewed in

entirety also leads to reduced ploughing back of funds for fuelling operations and a higher

debt perspective on the balance sheet.

Many companies have in fact initiated borrowing to finance their buyback programs.

This might bestow upon the company various tax advantages but at the same time it amounts

to replacing equity with debt. 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.

- 55 -

Buy back of shares

CONCLUSION:

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.

- 56 -

Buy back of shares

WEBLIOGRAPHY

www.blonnet.com

www.advanishares.com

www.indiainfoline.com

www.google.com

www.indiaheadlines.com

www.indiainfo.com

Newspapers:

The Times of India

Business Standard

Financial Express

Business Line

BIBLIOGRAPHY

Buyback of Shares – Ghosh

Inter – CA module

Financial Management- Prasanna Chandra

- 57 -

Buy back of shares

- 58 -