Why are cash-rich companies returning the money?

Jan 20, 2012

In this issue:
» Why are local currencies fast flourishing in the US?
» Sensex January 2012 performance best in decade
» Where is India's agriculture headed?
» Bleak outlook for global growth, emerging nations no exceptions
» ...and more!

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For a very long period that spanned over four decades, legendary investor Warren Buffett neither paid dividends to his shareholders nor initiated any share buybacks. As long as there were opportunities to invest and to earn a good return on capital, he found such exercises futile. But in September 2011, he shocked the financial world when he announced his plans to buy back shares of Berkshire Hathaway. It was a clear indication that there was a dearth of investible opportunities for the Oracle of Omaha. Given the bleak current prospects for the US economy, his change of stance is quite understandable.

But what's happening in India? Today, the board of Mukesh Ambani-led Reliance Industries Limited (RIL) will consider the proposal for a share buyback program which is touted to be one of the biggest share buyback programs in the history of India. The stock markets have given a thumbs-up to the news and the stock price of Reliance Industries has gone soaring in the last couple of days. It must be noted that the stock had been quite an underperformer in 2011, shedding about one-third of its market capitalisation.

But does the proposed share buyback mean good news? Well, the answer is both yes and no. Yes, because stock buybacks are like indirect dividend payments. By reducing the number of equity shares, it boosts the earning per share of the company.

But there is another way of looking at it and that makes us a little uncomfortable. The money that will be utilised to exercise the buyback could have been invested in building productive capacities, developing infrastructure and other such assets which in turn would have generated income and employment. In other words, the money is being returned to shareholders for lack of investible opportunities. But how can there be a dearth of opportunities in an emerging economy like India? In reality, the problem is not lack of opportunities but a bad business environment. Is it any coincidence that India ranks as low as 134th out of 183 countries on World Bank's 'Ease of Doing Business' index? What is even more disappointing is the fact that the case of RIL is not an exception but a trend. Several other cash-rich companies are also finding it quite difficult to deploy their funds into productive assets. Just a few weeks back we had written about how the cash-rich Piramal Group was also struggling to find viable investment opportunities.

This does not bode well at all for the Indian economy. In a growth phase, an economy akin to a corporate needs investments to keep the growth momentum. If that is not happening, then the future prospects of the Indian economy are certainly under threat.

So what does India need to get past the roadblocks? In one word, it is 'reforms'. Reforms that will make it easy for entrepreneurs to conduct business in a smooth manner. But will the government do anything? Not until pushed onto the brink of a crisis we believe.

Do you think cash rich companies are forced to buy back due to unavailability of viable projects? Share your comments with us or post your views on Facebook page / Google+ page.

 Chart of the day
While the year 2011 was one of the worst years for the Indian stock markets, the year 2012 has commenced on a pretty positive note. Since the start of the new year the benchmark BSE-Sensex has registered a rise of 7.7% so far. In fact, this is the best performance during this period in the last 10 years. The rise has been driven mainly by capital inflows by foreign Institutional Investors (FIIs) due to moderating inflation and possibility of monetary easing after a series of rate hikes by the Reserve Bank of India (RBI) in last two years.

Data source: Business Standard

Mention the term 'inflation' and the chances are that you will get a variety of definitions from different people. But according to us, the best of the lot was the one given by the famous economist Lord Keynes. He very astutely observed that inflation is a process where the Government confiscates, almost secretly and unobserved, an important part of the wealth of its citizens. And higher the inflation the greater the amount of confiscation we believe.

Is there a way to avoid this wealth destruction? There certainly is and the most conventional thing to do is to invest in assets that have a history of inflation beating returns. However, a growing number of communities in the US are adopting an even more radical strategy to deal with the economic woes of the country. CNN reports how this strategy is nothing but the usage of home grown local currencies. Not only have more local currencies started their operations but the membership for each currency has also seen a huge spike in interest. "With everything happening in the economy and the banking sector, people are paying more attention to their local communities and there's more awareness of keeping money in our community," observed an administrator of one of the currencies. Thus, with people's faith in the fiat money system fast dwindling, are we about to go back to the era of gold standard? Well, only time will be able to answer this.

All eyes are now on whether the upcoming Union Budget will offer more sops to manufacturing units, fiscal benefits to services and infrastructure and subsidies on crude. Agriculture that has enjoyed subsidy benefits year after year seems to be on the backburner now. In fact, this time there is a high possibility of fertilizer price rationalization, hike in diesel prices and some upward revision of electricity rates.

Will these reforms make the case of Indian agriculture any better? In a country where farmer suicides get largely ignored, statistics about rising farm output and increased demand catch media and government attention. While the growth rate of agriculture has not been too disappointing in recent times, the same can be attributed to low base effect. The average rural income level too seems to be heavily influenced by the income from schemes like Prime Minister's 'Rojgar Yojana'. Hence if the rise in farming costs make the activity unviable for small and marginal farmers, there is a high possibility of them quitting farmlands altogether.

Important to note that hired labour and fertilizers represent more than 60% of the total cost of cultivation. And these have seen rapid increases in recent years. Yet more than half the nation's youth is still employed in agriculture. Going forward, however, the employment in farmlands may be shunned by most. Hence, as correctly pointed out in an editorial in Mint, the challenge for the government is dual. It is not only to ensure a revival of growth in agricultural output, but also to ensure the revival in fortunes of those whose livelihood depends on it.

Europe and the US look like they will not be recovering anytime soon which means that the onus lies on emerging countries to spur global growth. But that is easier said than done. Growth in Asia has settled into a middle pace. It is neither fast enough to accelerate global GDP (Gross Domestic Product) nor is it so slow that policymakers can afford to ease policies.

Unlike the developed world where interest rates are already close to zero and debt has ballooned so as to leave little scope for more stimuli, Asian economies are not yet in such a sorry state. They still have headroom to cut interest rates and boost government spending. But given that many of the emerging nations including India have been battling inflation, easing rates is something that these economies may not rush to do.

The World Bank in the meanwhile has cut its global growth forecasts to 2.5% this year and 3.1% next year. While its outlook for the developed nations remains gloomy, the Bank does not have a rosy view of the emerging nations either and has warned them to have contingency planning in place lest another crisis of the same scope as the global financial crisis erupts. However, given that they have their own headwinds to face, emerging countries may not pay much heed to World Bank's warnings and may be content with the current pace of growth and policymaking.

Meanwhile, the Indian stock markets were trading in the positive territory but not before losing some of the initial gains. The BSE-Sensex was trading higher by 59 points (up 0.35%) at the time of writing. FMCG and healthcare stocks are trading weak while banking stocks are leading the rally. Major Asian indices are trading in the green with Japan and Korea leading the pack of gainers. European markets, however, have opened on a mixed note.

 Today's Investing Mantra
"You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing." - Warren Buffett

Click here to read our series on 'Lessons from Warren Buffett'

Kindly note that there will be no weekend issue of The 5 Minute WrapUp on Saturday, 21st January 2012.

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14 Responses to "Why are cash-rich companies returning the money?"

Louis Colaco

Feb 2, 2012

Simply sad based on my observation, the malady of our Nation is generally the lack of ethical values, integrity and the courage to stick our necks out in the interest of the nation and the common man. Our preoccupation is selfish interests. To my mind, the buyback is manipulative gimmick. This decade beckons the true sons of India to take calculated risks, invest and prosper and build our bleloved Nation with a sense of patriotism and a great vision.



Jan 23, 2012

Absolute faith on the never leave customers and helping those who are desperate in selling to realise cash. This consolidates panic selling.Class ! strategy. Good Luck for their customer care!Before a great leap!



Jan 21, 2012

Business people had created bad business environment in India. How come industries like Banking, Hospitality, Telecom, Auto are able invest year after year in their business. Because, they believe in their business. No one can make big money overnight anywhere in the world. More so in India. It took nearly 10 years for Bharti to pay dividend. Of course, people want gold through their roof overnight won't find any opportunity any where.


Lloyd Lobo

Jan 21, 2012

Its a good time to buy back shares as share prices are at relatively low and even with a slight premium it is still cheap. Good for investors who stay put. These companies could also raise equity again at a later date when markets are robust at a much higher price!


vivek raut

Jan 21, 2012

In India, do we have electronic chip manufaturer or lcd display module manufacturer. every thing we import. why can't company like reliance put money in electronic hardware manufacture & be net exporter. if we have to compete china, korea, taiwan, we should take up electronic, computer hardware manufacturing seriosly. instead of buying there own stock at 12000 crore, they can easily make a giant leap.


Tikam Patni

Jan 20, 2012

It is obvious that since Reliance is not finding opportunity to make business investment, it is utilising it's cash to buyback it's shares. This is also an opportunity to prevent erosion of it's market cap and hence the brand Reliance.Will it succeed?? Doubtful.

Further Reliance does a good job in capital intensive monopolistic industrial customer centric ventures. And it does a very poor job in direct retail customer centric ventures. Hence it is groping.


Vijay Sharma

Jan 20, 2012

Yes I agree with You. Group like Reliance are struglling to invest the surplus fund available due to non availability of profitability projects. There should be one representation / participation form bussinessmans in our politics to decide policies.
I think it is not a good news for the investor because it will spread to other companies and then to people. which will lead people to invest in commodities like Gold to get some return. Basically it will block the money and liquidity.



Jan 20, 2012

I do not think there is shortage of investment ideas or avenues.
Problem is , after all the hard work corrupts get the major share , where is the incentive left ?



Jan 20, 2012

It may be true for Groups like RIL or Piramal. But what about Companies like Alfa Laval or Atlas Copco? Do they feel they have lesser opportunities in India. To my mind it appears these Companies want to go back to the old regime of closely held Companies that too 100% foreign owned and not allow the Indian public to share in the income earned in India by them.


Piyush Singh

Jan 20, 2012

The substance of red-tapes - while conducting businesses in India is unquestioned. However, behemoths like RIL are too veteran to hold-back their investments in lieu of the infamous bureaucracy; same applies to the cash-rich Piramals. RIL's decision of share-buyback appears to be conscious one; rather, adhering to 'India's Growth Story' - one must see that the RIL is citing the valuations to be attractive; given: RIL has lost a major chunk of M-Cap in the recent bear-run.

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