Recently, IT giant Wipro announced a share buyback plan of a whopping ₹12,000 crores during their Q4FY23 earning release. Also, another IT giant, Infosys, recently concluded their ₹9,300 crore share buyback program, the fourth since their listing.
So, what are share buybacks, and why do companies spend huge sums on them instead of spending on growth projects? This article will answer all of your share buyback questions.
What are Share Buybacks?
A share buyback is when a publicly listed company buys back its stock from existing shareholders via an open market operation or a tender offer.
In an open market operation, the shares are purchased back from sellers on the exchange during the buyback period.
While in the tender offer process, the company announces the buyback price of its shares, often higher than the market price, and existing shareholders tender or sell their shares at the offer price, regardless of the market price of the shares.
Why Do Companies Consider Share Buybacks?
One of the primary objectives of any publicly listed company is to maximize shareholder value. Accordingly, they work to generate higher returns for their investors, i.e., through an increase in the price of the stock and paying cash dividends to shareholders.
A share buyback reduces the outstanding number of shares in the market. For example, Infosys’s recently concluded share buyback program, which ended on February 13, 2023, repurchased over 60 million equity shares, reducing 1.44% of the company’s pre-buyback paid-up equity capital. Thus, increasing Earning Per Share (EPS) and Return on Equity (ROE). In addition, as fewer shares are available, it drives up the price of shares due to higher demand.
There are additional reasons why companies conduct share buybacks, including these:
Excess cash reserves and a few projects to spend it on: There are many cash-rich companies in India, but only a few of them, particularly blue-chip IT companies, engage in share buybacks.
Unlike companies like Reliance and Tata Steel, which require massive capital investments to fuel their growth, IT companies work on matured business models with built-in systems in place that do not require huge investments. Therefore, one of the best ways to utilize the excess cash in the balance sheet is to engage in share buybacks.
Suppose the company maintains a higher level of cash for an extended period. In that case, the company’s management has not used the money for meaningful purposes. So, companies consider share buybacks whenever there is excess cash and few investment opportunities.
Consolidates ownership of the company: A shareholder of the company is entitled to voting rights on crucial decisions, and often companies find it challenging to come to a unanimous conclusion because of the large shareholder base. A share buyback helps to reduce the shareholder base and consolidates ownership. It helps in faster decision-making and makes sure promoters’ rights are protected.
Improves confidence in the company’s management: The announcement of a share buyback by the company’s board demonstrates management’s confidence in the company’s future growth potential. It indicates that the board anticipates an increase in the value of the stock and that the money invested in the share buyback program will yield a higher return.
The company also signals through buyback that the stock is currently undervalued and is a good buying opportunity.
Dividends vs Share Buybacks
Dividends are other excellent ways to redistribute excess cash on the balance sheet. Still, it is ineffective for businesses because they offer no extra benefit. Dividends don’t help companies reduce outstanding share capital or improve margins or leverage ratios. It reduces the retained earnings and cash but doesn’t help to push the stock price higher.
Increasing dividend payout increases shareholders’ expectations of higher dividends in the future. And, if the company fails to provide higher dividends, the stock price takes a beating. While in share buyback, companies can effectively use the excess cash to reduce the shareholder base and boost the share price.
For investors, dividends increase their tax liability as dividend income is taxed at the tax slab rates of the individuals. At the same time, profits earned from share buybacks are taxed lower. The long-term capital gains tax is 10%.
If the shareholder does not sell their shares during the buyback, they are only required to pay taxes on the increased value of their shares once they do.
What Happens to the Stocks the Company Buys Back?
The shares repurchased in the share buyback program are cancelled permanently, reducing the number of outstanding shares.
Or, it is held as treasury shares by the company until further disposition—for example, bonus issues or issuing for ESOPs. Treasury shares are not included in the total number of outstanding shares.
Effects of Share Buyback on Financial Statement
The funds spent on share repurchases will be reflected in the cash flow statement from financing activities. On the balance sheet, a share buyback would reduce total assets due to reduced cash holdings while also reducing shareholder capital.
What is the Share Buyback Process in India?
To launch a share buyback program, the company must follow various steps outlined by the market regulator and obtain approvals.
Step 1: It must notify all shareholders via stock exchanges where their stocks are listed that the Board of Directors will likely consider a share buyback proposal at its next meeting.
Step 2: The company must next inform the exchanges of the outcome of the Board meeting and outline the details of the share buyback program in the intimation.
Step 3: Following SEBI disclosure and MCA regulations, the company must seek approval from shareholders via postal ballot notice, and the results must be reported to the stock exchanges.
Step 4: The company has to make a newspaper publication in all leading dailies of the announcement of the share buyback outlining the details.
Step 5: In the final notice to stock exchanges, the company has to inform about the commencement of the share buyback program.
The company must report daily quantities purchased to stock exchanges until the share buyback program is completed.
Before the share buyback program ends, the company’s buyback committee must notify the exchanges of the last day of the program. Then, when the buyback is completed, it must inform the exchanges once more, followed by a public announcement via a newspaper advertisement.
What are share buybacks?
Share buybacks are corporate actions in which a publicly traded company buys back its stock from existing shareholders through a tender offer or an open market operation.
What happens in share buyback?
A share buyback results in the reduction of outstanding share capital in the market.
Who funds the share buybacks?
The company uses excess cash on its balance sheet to fund the share buyback.