Will the largest buyback create shareholder value?

Mar 5, 2012

In this issue:
» Your LIC premiums are funding govt deficit
» Will India Inc see sales slowing down?
» Power bills set to go up
» Banks' asset quality to deteriorate further?
» ...and more!

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Share buybacks are usually in vogue when stock markets are on a downward path. Many managements use it as an instrument to boost their share prices. Investors view it as a sign of commitment and faith that a company's management has in its own business. Even legendary investor Warren Buffett favours buybacks. But does it mean that all share buybacks are good?

Not really. As per Buffett ideally two conditions that should be met to make a buyback value accretive for the shareholders. One, the company should have surplus cash after taking care of its operational and liquidity needs. Two, the company's shares should be undervalued in the stock markets. In our opinion, another important criterion to look out for is the motive of the management behind the buyback. And this is where the country's largest ever announced buyback program fails.

The government of India has recently allowed the cash rich PSUs to undertake a huge share buyback. This includes Coal India, National Thermal Power Corporation, Oil & Natural Gas Corporation, Oil India, Bharat Heavy Electricals Ltd, Minerals & Mining Trading Corporation and Steel Authority of India. The buyback surely meets the first two of Buffet's criteria for a buyback. These companies have ample amount of cash. They are currently not overvalued either. In fact most of the PSUs are trading below or at fair valuations as well. But the underlying motive in this buyback is just to fill up the government's coffers.

The government of India is one of the largest shareholders in these companies. The buyback would help it to raise the revenues that it desperately needs to help meet its fiscal deficit target. However, it would do well to keep in mind that plugging the fiscal gap should not come at the expense of wealth destruction of the companies undertaking the buyback. Otherwise, not only will the image of the PSU companies suffer, it will leave the taxpayers even more impoverished than before.

Do you think the PSU share buyback program would be value accretive for the shareholders? Share your comments with us or post your views on our Facebook page / Google+ page.

 Chart of the day
India has been fighting a constant battle against containing its widening fiscal deficit. Unfortunately it has been a one sided battle with the fiscsal deficit leading the point tally till now. To try and bring down the gap, the government has pulled the brakes on its spending. As per a leading daily, the government has only spent 66.6% of its planned budget expenditure in the first 10 months of FY12. This is the lowest ever since FY05. Unfortunately it is not the expenditure that is responsible for the fiscal mess. It is the growing burden of subsidies combined with declining revenues. So the ideal solution would be to cut back on subsidies. But in an election year, would that move ever be made? Not likely!

Data source: The Mint* For the period April to Jan

Is it sensible for an insurance company to invest the money it gets from selling insurance policies into stocks? It certainly is we believe. After all, one of the best businesses in the world, Berkshire Hathaway, has this very philosophy at its core. However, what if the investing decisions at the insurance company are not being taken from an economic point of view? Instead, the insurance company is accused of acting as a lender of last resort. And also of accumulating shares which have destroyed wealth over a period of 2-3 years. Isn't it a different matter altogether? It certainly is.

Allegations of a similar kind are being leveled against LIC, India's largest life insurer. As per reports, small policyholders of the insurance behemoth are being forced to picking the tab for the Government's ambitious disinvestment programme. What else would explain the fact that LIC is sitting on notional losses worth Rs 30 bn. All of it on account of participation in the Government disinvestment programme since 2009. The stake selling spree is not over yet. Only recently, the insurance giant's help was again called for in the ONGC FPO. Here too, the rationale seemed to be anything else but economic. We believe it is time the Government quits playing tricks like these to improve its deficit scenario. Else, faith on revered institutions like the LIC will be lost on forever. Making this similar to killing the goose that laid golden eggs.

India Inc. reported mixed results for the December 2011. Sales of 352 BSE companies were robust as growth stood at 25%. But margins and profits were hit. Profits grew by a tepid 4.6% as margins dropped 13.6%. The reasons for this are well documented. High interest rates and rising raw material prices were the main culprits that dented profits even though sales were healthy. Does this mean that the worst is over and we can look forward to better times for India Inc? Not really. Because while profits were under pressure so far, it is now likely that sales growth will go through challenging times in the coming quarters as well. One of the reasons that the robust sales growth of the current quarter will not be sustainable going forward is the decline in demand. For starters, the government's finances are a mess. Thus, it is likely to raise taxes in the coming Budget and will look to reduce subsidies. The latter could result in higher fuel and electricity prices. All of which will burn a hole in the wallets of consumers and reduce their propensity to consume. Thus, sales growth of Indian companies is also likely to slow down. From a long term perspective, the only way to ensure healthy growth in sales and profits is for the government to introduce reforms which will speed up investment activity. Only time will tell whether this will happen.

If you hoping for your household budget to get less stressful next fiscal onwards, trust us, that is unlikely to be the case. Here we are not just harping about the stickiness of food inflation. Nor are we completely ruling out any chance of the Reserve Bank of India lowering interest rates. Which in turn could impact your monthly installments (EMIs). But what seems reasonably certain is the rise in utility bills given the cash crunch in government finances. Besides the subsidy on LPG, the other item that may take a hit is the subsidy in power tariffs. Power distribution companies, as we know, are in dire state of finances. These entities are currently losses to the tune of Rs 820 bn! The lower power tariffs, of course are not entirely to blame. For the distribution losses in India, at 30%, are amongst the highest in the world. 44% of India's population is deprived of electricity access. However, nearly 50-60% electricity generated is lost during distribution in north-east region and Bihar. However, power companies are looking at up to 33% rise in tariffs next fiscal onwards. This may bring some relief to banks and financers with large exposure to power projects. However, the consumers of power, whether corporate or retail, will see spurt in costs.

In a tough economic environment the asset quality of a bank takes paramount importance. Heavy provisioning and rising bad loans directly affects the bottom line of banks. Managing this risk really separates the men from the boys. Almost all lenders, especially public sector banks have seen a spike in their non-performing assets (NPAs) so far. But, in this case, private banks have performed much better than their public sector peers. High interest rates and slack economic growth has helped contribute to the mess. Rating agency ICRA expects asset quality to deteriorate even further on account of fundamental issues in certain sectors and the rising proportion of banks restructured book.

All this may have another undesirable affect. India's central bank has put rate hikes on hold for now and has even cut the cash reserve ratio (CRR). However lending rates may continue to remain high as accelerated provisioning could prevent banks from reducing their yields. They may thus try and safeguard their profits by keeping rates at elevated levels. This could in turn affect the repayment ability of borrowers. A vicious cycle.

In the meanwhile, the Indian stock markets continued to languish after opening the day in red. At the time of writing, BSE Sensex was down by 282 points (1.6%). All major sectoral indices were trading in the negative. Barring Malaysia, all the other Asian stock markets closed the day in the red as well.

 Today's Investing Mantra
"The stock market is filled with individuals who know the price of everything, but the value of nothing." - Philip Fisher

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7 Responses to "Will the largest buyback create shareholder value?"


Mar 6, 2012

Share holders holding less than 300 shares or around two lac rupees in the public sector companies will at least get back their investment without loss if any buyback is announced. In that sense the government's action is welcome. The best way to go forward in reducing subsidies is to protect the comman man and lower middle classes with income less than two lacs per annum. For that you have to retain the subsidies for food and employment but eliminate altogether subsidies on LPG, Electricity and others I have failed to mention here. The government will survive in the elections as the lower middle class will feel happy that their interests have been taken care of while they have no grouse against those who are upwardly mobile since they will be actually charged for the utilitarian services offered by the government.


Khushru Tavadia

Mar 5, 2012

To bring fiscal deficit under control is important but not at the cost of integrity of the stock market, by indulging in this type of game govt is sending out wrong message to the market that if we cant sell it by tit will will sell it by tat. In the words of ex fin minister Mr Sinha this is day light robbery.

Like (1)


Mar 5, 2012

Govt. is not bothered whether it brings value to the share holder or to the company. Their goal is to raise some fund some how or other to carry out their personal agenda and come back to the power next term.

If any expectation of that sort is a DREAMMMMMMMMMMMMMMMMMMMMM.

Oh GOD save innocents.

Like (1)


Mar 5, 2012

If PSUs are cash rich so that they have ample cash for their operations in any near future captive requirements and share price is grossly undervalued, any access cash used for buy back will be value accreative for the existing shareholder.

How does it matter if underlying motive is to fill govt coffers which happens to be major shareholder. Buy back will offer same advantages to the minority shareholders as well. Am I missing something.

Like (1)


Mar 5, 2012

Remove ALL subsidies and LOSE the elections.

It'll be a WIN-WIN situation for the country and its residents.

Can't the UPA make this much sacrifice for the benefit of the nation?

Guess not... patriotism is only meant for speeches. They can talk the talk but not walk the walk.

Like (1)

Suresh Kumar

Mar 5, 2012

What is the objective of listed PSUs ? Is it shareholders wealth maximization in the long term or the government fiscal deficit minimization in the short term ? How should cash rich corporates handle their surpluses ? Should it be for expansion, rewarding the shareholders or for buy-backs, if the share prices trade at a value much lower than the fair price despite good market sentiments ?

The equation gets much more complex, if the biggest shareholder votes for lower profitability by selling the products below the fair market price. So, the problem sounds peculiar as to how to maximize shareholder value in the short term by keeping the product price lower than the market value. Its probably possible by keeping volumes very high, which also requires capex, ruling out buybacks through surplus. There is no possible solution to this problem.

Like (1)

Ganapathy Sastri

Mar 5, 2012

There is a dire need to CONSOLIDATE (just as holding companies with subsidiaries are required to do now) the deficits of government with the losses and gains of PSUs, banks and LIC, GIC, oil marketing companies. Only then the true deficit will be known. Without consolidation, there is always a temptation to transfer money from one pocket to another to make the latter look better since everybody looks only at one pocket. People of India are entitled to know the truth however unpleasant it may be.
The reality is there is a MASSIVE inflation during the last four years and during the last six decades since we had independence. Government of India should take the major responsibility for this. Just think: thirty years one could buy property for one lac. Thirty years from now, one can have a proper tea ( in a five star). That is the extent of inflation brought on to this country.
Like everybody else, the government should LIVE WITHIN ITS MEANS of non refundable inflows and resort less to refundable inflows and sale of assets.
The government is trying to reduce its deficit and has done so in the past by selling its crown jewels. In the past, the value of these assets went only UP after sale and it will be now different now. So why at all sell these assets??

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