What is Share Buyback/Repurchase?
Share or stock buyback is when companies decide to purchase their share from their existing shareholders through a tender offer or an open market. In such a situation, the price of the concerned shares is higher than the prevailing market price.
When companies opt for the open market mechanism to repurchase shares, they can do so through the secondary market. On the other hand, those who choose the tender offer can avail of the same by submitting or tendering a portion of their shares within a given period. Alternatively, it is a means to reward existing shareholders other than offering timely dividends.
However, company owners may have several reasons for repurchasing their stocks. Individuals should make a point to find out the underlying causes to make the most of such decisions and also to benefit from them accordingly.
Reasons for Share Buyback?
There may be several reasons why a company opts for a stock buyback. However, the list below highlights the most common reasons for the same.
1) When There Is Excess Cash But Not Enough Projects To Invest In
Companies issue shares to raise equity capital and expand their venture, but often such a practice does not prove to be of much use. Similarly, keeping excess money at the bank is more like a truncated cash flow offering liquidity over the ideal requirement. Hence, companies with robust financial standing tend to make the best possible use of the cash available through a stock buyback instead of piling on cash reserves.
2) It is a Tax-effective Rewarding Option
Share buybacks are more tax-effective than dividends for both companies and their shareholders. To elaborate, stock buybacks are subjected only to DDT, and the amount of money is deducted before distributing the earnings to the surrendering shareholders. On the other hand, dividends are taxed at three different levels.
3) To Consolidate Hold Over the Company
Often when the number of shareholders of a company exceeds the manageable limit, it becomes challenging for the entity to reach a decision unanimously. Additionally, it may result in a power struggle within the company and among the shareholders with voting rights. To avoid or aggravate such situations, company board members often resort to share buybacks and plan to consolidate their hold over the company by increasing their voting rights.
For instance, OYO Rooms’ attempt to repurchase shares worth $1.5 billion from Lightspeed and Sequoia Capital is one of the most recent examples of the buyback of shares in 2020. The success of such a proposal would increase the company CEO’s current shareholding from a meager 10% to 30% and strengthen his hold over the company.
4) To Signal that the Stock Is Undervalued
When a company decides to buy back its shares, it may also indicate that it considers them undervalued. Besides serving as a remedy for the situation, it also helps project a positive picture of the company’s prospects and current valuation.
Other than these, stock buybacks may be prompt to improve companies’ overall valuation or to reward their existing shareholders.
How Is a Buyback Done?
A company can make a tender offer, at a premium over the current market price, to shareholders where they have the option to submit all or a portion of their shares within a given time frame. Alternatively, a company may have an outlined share repurchase program that purchases shares on the open market at certain times or regular intervals over an extended period. A company can fund its buyback by taking on debt, with cash on hand, or with the cash flow from operations.
Advantages of Buy-Back of Shares
Stakeholders Benefit
- This buy-back allows you to buy shares at a lower price, return them at a higher price, and get a good capital gain in a short period.
- Despite the low market price, the company is repurchasing shares at a higher price, so the overall market outlook.
- on the company can be positive. Therefore, this company’s price is likely to increase further in the future.
- Shareholders who earn more than Rs 10 lakh per annum in dividends are taxable. Instead of paying dividends, they may be subject to lower tax returns.
- As the buy-back reduces the number of shares in the market, the price of the company may go up after the buy-back as per the demand-supply rules.
- This increases the liquidity of the shares.
The Benefit to the Company
- If a company/promoter is confident that the credit of their company is much higher than the market price, then the company can prove its confidence in the market by bringing a buy-back proposal.
- After the buy-back, the company’s share capital decreases, but there is no reason for the incident to affect the company. Therefore, even if the company’s income remains the same, it is divided into fewer shareholders. The result is an increase in the company’s stock.
- Often after a buy-back, the company’s market value rises sharply.
Appropriate use of cash – Cash Management
- Cash accumulated by companies is sometimes not necessary for a new project. In such a case, the company can return the inactive cash to the shareholders as a buy-back. But it also implies that the issue is not in front of a new incremental project. This is sometimes seen in a negative light in the market.
- But in most buy-back cases, the company is viewed with confidence.
Government Benefits
Shortly we see the government trying to achieve its investment target through buy-back. This makes it possible for the government to raise a large amount of money for development. The repurchase of various government companies is an indication of this. E.g., The buy-back scheme of companies like Indian Oil, ONGC, and Bharat Electronics was recently implemented. In addition to the government, ordinary investors can also take advantage of this scheme. The investment target of Rs 80,000 crore a year and the promise of many repurchase opportunities in the years to come.
Disadvantages of Buy-Back of Shares
- Reduces cash surplus with the company.
- Fear of share price manipulation.
- It could divert away the company’s funds from productive investments.
- Buy-back can cause a shortage of shares.
- Buy-back is always the company’s last option to use cash.
- Buy-back has its own risk.
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