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Buyback: Enhancing shareholder wealth?

Jul 21, 2001

'Generating shareholder wealth' seems to be the latest tune played by India Inc. Year to date, domestic and foreign companies have lined up to return idle funds to their rightful owner -- the shareholder. Is the sun finally shinning on the retail investor?The Securities & Exchange Board of India (SEBI) passed the Buy Back of Securities regulation in 1998. The passing of this regulation could have been expected considering that the Board had passed the Substantial Acquisition of Shares & Takeovers regulation in 1997. The buyback regulation provides a fair chance to the incumbent management to protect their turf in case of a hostile takeover. Under the buyback regulations, a company may repurchase its shares under the following route:

  • Buyback through tender offer
  • Buyback through open market
        1. Stock exchange
        2. Book building

    No. of Buyback offers opened over '01 & '02
    CompanyOpen marketTender
    Fortune Financial Services P
    Mico P
    Finolex Cables LtdP 
    Mico P
    Jayshree Tea & Ind. Ltd. P
    Neelamalai Agro Ind. Ltd. P
    TTK - LIG P
    Selan Exploration TechnologyP 
    Gandhi Special Teubes Ltd. P
    Bajaj Auto P
    Bhagyanagar Metals Ltd. P
    Raajratna Metal Ind. Ltd. P
    Carborundum P
    John Fowler (I) Ltd. P
    Reliance Ind. Ltd.P 
    KCP Sugar & Ind. Corp. Ltd. P
    Great Eastern Shipping Corp.P 
    Raymond Ltd.P 
    Selan Exploration TechnologyP 
    Finolex Ind. Ltd.P 
    India Nippon Electricals Ltd. P
    Jayshree Tea & Ind. Ltd.P 

    In calendar year 2001, six of the eight-buyback offers that have opened are through the open market route. In fact, majority of the recent buyback offers announced have adopted this mechanism including Bombay Dyeing, Britannia, Siemens, Indian Rayon and GE Shipping. However, are the intentions of the management to genuinely promote shareholder wealth? Or is it a route to increase promoters' percentage shareholding.

    Under the tender offer the company has to repurchase its shares at a particular price, as mentioned in the public announcement required by regulation. While in buyback through the stock exchange the company has to announce the maximum buyback price while the actual price may vary from this announced price. Further, the buyback of shares, under open market, shall not be made from promoter or persons in control of the company. Weak market conditions with low company valuations could be a suitable time for promoters to hike their percentage shareholding -- with threat of takeovers becoming reality. Also, under the stock exchange route, in a declining market the actual repurchase price could turn out to be significantly lower than the maximum buyback price. Nevertheless, only the promoter - management is not be blamed, as the shareholders through special resolution approve the buyback programme. The special resolution is to be passed in a general meeting with specified quorum and 75% majority. With poor shareholder activism in the country -- promoters get away -- retail investors cannot complain.

    Fair value of equity shares pre buyback = F.V
    Fair value of equity shares post buyback (Residual value) = R.V
    Buyback price = B.P
    Case 1. B.P = F.V, then, R.V = F.V
    Case 2. B.P > F.V, then, R.V < F.V
    Case 3. B.P < F.V, then, R.V > F.V

    Ideally, the company should repurchase shares at the fair value, as both classes of shareholders, exiting and continuing, are not penalized for their actions. Under Case 2, the continuing shareholder is penalized, as he is worse off after the buyback at the expense of the exiting shareholder. This case is similar to the US - 64 fiasco. Under Case 3, the exiting shareholder is penalized, as he is not offered the fair value while the continuing shareholder is better off post buyback at the expense of the former. To put things into perspective, assume fair value equal to book value (net worth). Substituting for the above cases.
    Case 1 B.P = B.V, then, R.V = B.V
    Case 2 B.P > B.V, then, R.V < B.V
    Case 3 B.P < B.V, then, R.V > B.V

    The charts exhibit the respective companies stock price performance over a window period of 1 month before and after the announcement. All the stocks have underperformed the Sensex after the announcement date except Bajaj Auto, which announced a buyback through the tender offer. The other companies have opted for buyback through stock exchange.

    On June 14, 2001 Britannia announced buyback of shares through the open market route. The company stated it would purchase the shares at a maximum price of Rs 750 (15% premium to the prevailing market price of Rs 652) with a total outlay allocated for the purpose at Rs 550 m. Further, the announcement was for a maximum buyback of 1 m equity shares. Attempting to arrive at a price the company believes reflects the fair value of an equity share is a futile exercise. Announcement on the maximum buyback price could be interpreted as a ceiling (under the current business scenario). Whereas, an implicit floor price at Rs 550 could be construed in case of the company repurchasing the maximum number of shares at the maximum outlay. The management has been ambiguous as to what it believes is the fair value of its equity share with the floor and ceiling price varying by 36%. The six-month average price on date of announcement was Rs 724.

    The Britannia stock price has fallen since the announcement date to Rs 595, which could signal a thumbs down to the announcement (besides the FMCG market is witnessing a slow down). Has the noble intention of enhancing shareholder value done a volte-face. The stock, technically, seems to be weak and could be heading to the implicit floor price of Rs 550, as ambiguity prevails on the actual buyback price.

    The shareholder, a part owner of the business, expects to be compensated at a fair price for his stake in a business. The secondary market allows the shareholder to exit the business at a price, which the market estimates is a fair value of the equity share. However, at times, market estimates may not reflect the true value of an equity share. But by selling in the secondary market the shareholder is knowingly exposed to the risk of not being compensated at the fair price. One would assume that the company has a 'fairer' estimate of the value of its business. In case the shareholder is exiting the business by selling his shares to the company, one would believe that the other co-owners would compensate him at this 'fairer' value.

    Reliance Industries too is guilty of such action. The company announced a buyback programme of shares last August, which has been extended for the full fiscal of '02. The company proposes to buyback shares at a maximum price of Rs 303 with a total outlay of Rs 11 bn for this purpose. In case the management executes this programme at the above-mentioned limits the number of shares stand reduced by 36.3 m (3.4% of outstanding shares). As per the annual report no shares were re-purchased as the RIL share traded below the maximum price on only 11 days of the first buyback period. This could raise doubts on the intentions of the management and their genuineness in buying back shares. The special resolution approved by shareholders is for re-purchasing shares at a maximum price of Rs 303 and not 'only at' Rs 303. Further, this could indicate that the company is a buyer only if the RIL share trades below Rs 303 for a 'reasonable' period of time. This could create an artificial support price with the market aware that a buyer exists below the indicated price.

    Also, assuming that Rs 303 represents the fair value of a share the management wants to compensate the shareholder, a part owner of the business, at a price below fair value. How fair is that? Further, the chairman's statement reads that the company believes its shares to be undervalued (RIL share trades above Rs 303). This raises the questions as to why the company is compensating the shareholder below fair value. The aim, one thought, was to enhance shareholder wealth?

    Although the intentions of the regulator may not have been malafide the possible loop holes available in the regulations could allow promoters / managements to pursue objectives, which may not be entirely in the interest of the retail investor. Does the sun shine on the retail investor?

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