BUYBACK OF SHARES

INTRODUCTION
Buyback or share repurchase to return capital to shareholders has assumed significance during 1995-97. It is considered as a legitimate method of defense by companies facing hostile takeover. In 1998 SEBI regulation provided for buy-back of shares of listed companies. In buyback of shares cash is used to buy back a part of outstanding shares of the company, reducing the total number outstanding. It leads to a reduction in dispersion of ownership of shares.

 In US companies can buy back shares through three methods:

1. The fixed price tender offer 2. The Dutch auction tender offer 3. The open market repurchase program

FIXED PRICE TENDER OFFER

Fixed price tender offer involves the firm offering a single price to all shareholders for a specific number of shares. The features are:
1. The offer is valid for a limited period 2. The offer may or may not be contingent 3. In case of subscription prorata purchase is made

DUTCH AUCTION TENDER OFFER

It is a fixed price deal. But it is arrived at by soliciting individual offers from shareholders to participate by choosing the price from the range offered and the number of shares they are tendering. At the close of the offer periods management collects the individual offers and sorts them by price. The precise price level at which the repurchase is completed is determined by adding the number of shares offered starting at the lowest end of managements price range. The price stops at that at which the cumulative no of shares equals the size of the repurchase program.

 These two approaches Fixed price tender offer and Dutch auction allow management to achieve:
1. Efficient way to retire large block of shares in a relatively short period of time. They are ideal for making changes in capital structure 2. Signal to the market that the firm is undervalued

The fixed price tender offers on an average about 16% premium, and in Dutch auctions the premiums are smaller about 12.5%

OPEN MARKET PURCHASE

The preferred technique is open market purchase program. In such cases, companies either directly or through intermediaries buy their own stock on the open market. There is no limit or duration on program size, but studies reveal that typical open market program is for 5% of share base. Companies take three years on average to complete the open market repurchase program.

MOTIVES FOR BUY-BACK

EFFECT OF SHARE BUYBACK ON VALUE OF FIRM: It assumes that the firm has idle or unproductive assets and by getting rid of them the firms productivity increases. Shrinking the size of the firm adds value only if the firm is failing to earn its cost of capital on investment. The real source of gain is reallocation of capital to higher valued uses. If repurchase is financed by borrowing, earnings may increase but financial risk also increases. For companies in declining industries the decision to shrink the firm by buy-back may turn out to be a value increasing strategy.

continued
BOOK TO MARKET RATIO Companies with high book to market ratio are often viewed as value stocks and perceived undervaluation is likely to be a primary factor in the decision to repurchase. Stock markets take a favorable view of the shifts from dividends to stock purchase. Companies may use small open market purchases to fine tune their leverage over time.

ACCOUNTING FOR BUY-BACK

The accounting methods that could be followed are reduction of capital or reduction of treasury stock. In reduction of capital method, when a company buys its own shares they are deleted from the capital. Since a buyback operation is done either through an open market purchase or an open offer, the purchase price is generally higher than the face value of the shares. The face value of the total number of shares would be deducted from the equity base and the difference between face value and the open offer price would be deducted from reserves.

continued In the reduction of treasury stock method, the shares purchased are not deleted or extinguished. They are transferred into a special reserve as treasury stock and are classified as unissued authorized capital for accounting purposes. The shares can be issued at a later date. The shares purchased can also be kept in the form of other investments without reducing capital. They can be sold later at a higher price

PROVISIONS IN COMPANIES ACT, 1956

Reduction of capital which results from buyback of shares is dealt with in sec 77 and 100 to 104 of the Cos Act. Sec 77states that no company limited by shares shall have the power to buy its own shares unless the consequent reduction of capital is effected and sanctioned in pursuance of Sections 100 to 104 or Section 402 of this Act. The reason for the restriction is that such a purchase amounts to trafficking in its own shares to influence price or indulge in insider trading and constitutes reduction of share capital bypassing the procedures laid down in the Companies Act.

REASONS FOR ALLOWING BUY-BACK

Apart from blocking a hostile takeover, share repurchases offer companies to 1. Return surplus cash to shareholders 2. To increase underlying share value 3. To support share price during periods of temporary weakness

DEFENSE AGAINST TAKEOVERS

As a defense mechanism from unfriendly takeovers, promoters will benefit. Companies with a low promoter holding and large floating of stock are likely to benefit from buy-back. The promoters will be in a position to increase their holding by acquiring shares and warding off any take over threat.

IMPACT ON EPS
It is widely claimed that the 5000 companies listed on stock exchanges are undervalued. Buyback will result in a large inflow of funds in the capital markets. Further, buybacks are the most tax efficient means of distributing excess cash to the shareholders and generally signals managements positive outlook on the stock price. Buyback acts as an extra pay out in the form of higher post buyback value of shares. Companies with large capitalization who are neglected on account of low EPS & large floating stocks may become attractive.

BUYBACK AND INSIDER TRADING

The procedure prescribed for buyback of shares-a special resolution by share holders and the conditions laid down, namely,
That the funds for such buyback can only be drawn from free reserves and the share premium account And the company will not issue any new shares except bonus shares for a period of 12 months after the buyback is completed

If it is known that a co has decided to buyback shares, those who know, could front run the purchases and prop up the prices, appropriating the gain. SEBI does not have the resources to monitor such wrong doings like SEC in USA.

ADVANTAGES OF BUYBACK
It may provide a way of increasing insider control in firms, for they reduce the number of shares outstanding. If the insiders do not tender their shares back, thy will end up holding a larger proportion of the firm and consequently, having a greater control. Equity repurchases are much more focused in terms of paying out cash to those stockholders who need it. The decision to repurchase stock afford firms much more flexibility to reverse themselves to spread the repurchase to a longer period than the decision to pay an equivalent special dividend

 In case of equity repurchase, shareholders have option not to sell their shares back to firm and therefore they do not have to realize capital gains in the period of the equity repurchases. If stock buyback is opted for then both firm and individual stockholder stand to gain. Unlike regular dividends, which imply a commitment to continue payment in future periods, equity repurchases are viewed as one time returns of cash. Equity repurchases may provide firms with a way of supporting their stock prices when they are under assault. Achieve even higher overall shareholder value enhancement. Manage volatility in share price. Neutralize the impact of speculative forces and attract long term investors.

 Send powerful signal to the market on perceived undervaluation Improve financial parameters like ROE, EPS and optimize WACC, thereby enhancing global competitiveness By issuing debt (source of financing) and buyback its stock companies should be able to increase its leverage and accomplish financial restructuring. In summary, buyback serves two functions first it facilitates a more efficient allocation and two, imparts stability to prices.

DISADVANTAGES OF BUYBACKS Manipulation: If companies are allowed buyback of shares, management may resort to manipulation. They may, through collusive trading, depress prices, create anxiety among common investors, and tempt them to sell the shares to the company by making apparently attractive offers. Corporate energies may be diverted from the main business of the company to stock market games that may hurt the more gullible shareholders. A company that has long term plans would not indulge in such practices.

SEBI Regulations for Buyback

The buyback of he company has to be financed out of free reserves or securities premium account or from proceeds of earlier issue of dissimilar shares or other securities. The maximum time allowed for the completion of the buyback process is 12 months from the date of the relevant resolution Buyback can be done from existing security holders on proportionate basis, or from employees and directors out of the ESOP shares or through open market purchase A declaration of solvency has to be filed with the ROC and SEBI with a verification through an affidavit by the BOD of the company that they believe that the company will remain solvent for a period of 12 months from the date of such declaration

 All securities that have been bought back have to be destroyed within 7 days from the date of conclusion of the buyback programme No company will make a public issue of the same kind of securities that have been bought back within a period of 6 months from the conclusion of the buyback programme except through issue of bonus shares or through conversion of outstanding convertible instruments Two buyback programmes shall be separated by a period of 365 days even if they are for dissimilar securities The buyback should be a direct purchase by the company and not an indirect purchase through its subsidiaries or group investment companies.