Buyback goes out of fashion
Jan 08 2012
At any given point of time, bullish or bearish, promoters and company managements have the best valuation estimates of a business or a stock. For, they know the health of a business and its prospects at a particular stage like the back of the hand.
By an extension of this line of thought, promoters and companies should ideally be the first value buyers of a stock when it plunges abnormally, which is usually the case as it offers a great opportunity to accumulate cheaper equity to encash upon at a later stage.
But this has not been the case this time around. After a prolonged and sharp correction that saw equity market benchmarks correct as much as 25 per cent and hundreds of stocks drop to their 52-week lows or even lower over the past year, barely two-and-half dozen companies have come out with offers to buy back shares, which is not even 1 per cent of the total universe of listed firms.
One would have expected a rush to buy back shares at this stage for three key reasons.
First, even though both external and internal headwinds pounded the domestic economy pretty badly throughout 2011, there is nothing fundamentally wrong with the business environment, and the long-term outlook of the economy remains strong. With the peaking of interest rates and a fall in inflation, things are set to look up quickly enough, which means it is only a matter of time before the stock market starts climbing again.
Secondly, there would be a host of companies that would be looking to delist their shares before the 25 per cent public holding norm comes into force in a year’s time. The present downturn offers the best opportunity to further reduce their existing public float at a cheaper cost.
Thirdly, there are companies — and a few big names in that — where small promoter holdings leave them exposed to potential hostile takeovers under the new takeover norms. The present trough of the market presents them with a good chance to fortify themselves. Some of the IT companies and others may also need to buy back shares to cover large employee stock option programmes.
But the absence of any of the three categories of share buyers may give rise to varied interpretations. Astute investors may read in it signs of further bearishness in the days ahead. For, it is possible that promoters and company managements expect the market to fall further and are waiting for an even lower point to launch share buybacks.
It is also possible that the year-long economic downturn, demand squeeze and liquidity crisis have left companies so distraught they don’t expect to stage a quick rebound themselves anytime soon. Alternately, it may also reflect on very low cash levels in the coffers of India Inc.
Different market experts have different takes on the situation.
“I would not agree if you say promoters and companies are not buying shares. There may not be too many buyback offers, but many companies would be definitely buying shares in the open market,” said Gaurav Dua, head of research at Sharekhan.
“I would also like to think that more than companies themselves, promoters would be buying shares at individual levels,” Dua said. Under the rules of creeping acquisition, a promoter may freely acquire up to 5 per cent equity from the market in a financial year.
In a share buyback, a company offers buy a certain number of shares from existing shareholders at a fixed price (usually at a premium to the ruling market price) within a specified time frame. Companies also often buy shares in the open market over a period when the stock’s price is highly depressed.
Zee Entertainment, Reliance Infra-structure, Balrampur Chini, Praj Indu-stries, Ansal Housing, Indiabulls Real Estate Crisil, Amtek Auto, OnMobile Global, Monnet Ispat, PVR, Allied Digital and Monnet Ispat are among the 33 companies that announced share buyback plan over the past one year.
Prashant Sharma, chief investment officer of Max New York Life Insurance, felt most companies are not really in a situation to buy back shares as they are suffering from high debt and high interest costs. “Cash-rich companies are better off, but they are already trading at a significant premium to market multiples,” he pointed out.
Technically, one of the main reasons of a share buyback is to offer a temporary boost to a stock if the company feels it is suffering from low financial ratios relative to its peers and the broader market. And when the broader market itself is down in the dumps, a situation of this kind is unlikely to arise.
“The cost of liquidity is very high in the market,” said Pankaj Pandey, head of research at ICICIDirect.com. “So, share buyback won’t really work out to cheaper equity buying,” he said.
Pandey said the first priority of companies would be to unburden themselves of their debt loads and keep a little cash and watch how the liquidity situation unfolds over the next few months.
“A share buyback will possibly make sense if a company is cash-flow positive. It won’t make sense for a capital-intensive business. Share buyback would not be their top priority,” he said.
Dua said in a situation like this if a company is sitting on a large sum of cash, it would make better sense to deploy it for expansion and look at M&A opportunities instead of buying shares.
A share buyback generally spells good news for investors, as it allows them to exit depressed stocks at relatively higher prices compared with their market prices. Such an offer also gives the stock a temporary lift as it reduces dilution and increases shareholder value. What more, a buyback offer reflects a company management’s confidence in its business, thus it can assure the investor of a relative safety of investment, though it is not necessarily the case always.
(With inputs from Amit Mudgill)