What are Buybacks?
In a buyback, a company uses internal resources to buy back its issued equity, generally from non-promoter shareholders. The shares bought back are extinguished, resulting in a corresponding reduction in the company s equity. A company can buy back its shares through either of two methods by making a tender offer to all its shareholders at a pre-determined price and buying back on a proportionate basis, or by buying in the secondary market at market prices. In both cases, while announcing the buyback, a company must specify the maximum percentage of equity it plans to buy back, the maximum price per share it will pay and the funds earmarked for this exercise. Why buybacks? The textbook explanation for buybacks is that a company has surplus cash but insufficient profitable avenues to invest the same. In such a situation, the company may use these surplus funds to buy back its shares, and increase shareholder value. Since the shares bought back are extinguished, the post-buyback earning
The process of buybacks is based on the idea of controlling the buyer’s market that is associated with the stock of a particular company. Essentially, buybacks involve repurchasing outstanding shares of stock as a means of limiting the number of shares that are available for purchase by investors. As a way of managing the performance of the company’s stock during a soft market, the buyback approach can be very effective. Essentially, a company may choose to engage in a buyback as a means of managing the supply over demand. By limiting the number of shares that are available for acquisition, it is possible to turn a buyers’ market into a sellers’ market, at least for the one company. Less available shares may create enough interest that the demand for the remaining open shares that the company can choose to slowly release additional shares to the market, when and as it chooses. In addition to influencing the buyer’s market, buybacks can also have a positive impact on the company itself.
A buyback is essentially the reverse of a public issue. While in the latter, a company raises money from the public to fund expansion or diversification, in the former it returns cash to its investors. So, money actually flows in the reverse direction — from the company to shareholders. This cash for funding buybacks comes from various sources. In some cases, it’s from the sale of assets (like Madura Coats and Raymond), while in others it’s from a mountain of cash collected over the years (Bajaj Auto). In the context of buybacks, mountains of cash doesn’t mean the absolute amount of cash with a company; rather, it is a company’s cash holding as a proportion of its net worth. Hence, even a company of a smaller size (Crisil, to name one) could be said to be sitting on a mountain of cash. Why buybacks? Historically, managements have considered themselves to be the rightful guardians of the cash their company generates – they decide where the cash is to be invested. Unfortunately, the tra
