Share Repurchase

Dividend Vs. Stock Repurchase:

factors influencing choice
• Undervaluation of the firm
• Management Compensation
• Taxation impact
• Capital structure adjustment.
 WHY DOES A FIRM BUY BACK
SHARES?
• Signaling Effect-
– Cash flow signaling
– Market Undervaluation
– Investment in own shares
• Agency Costs-
– Distribution of free cash flows
• Leverage Effect-
– More Levered Capital Structure
– Debt disciplines management
• Takeover Defense-
– Get rid of dissatisfied shareholders
– Consolidate control
• Capital market allocation
Share repurchase: regulatory
environment in India
• Section 77A of the Companies Act:
– Sources of funds for buy back-
• Free reserves
• Securities Premium
• Proceeds of any shares or other specified securities
– Buy back is equal to or less than 25% of total
paid up capital and free reserves.
– Buy back of equity shares in any financial year
shall not exceed 25% of total paid up capital in
that financial year.
Share repurchase: regulatory
environment in India
• Debt-equity ratio post-buy back not to
exceed 2:1.
• Every buy back should be completed
within 12 months of passing a special
resolution to this effect.
• Special resolution is not necessary if the
buy back percentage does not exceed
10%.
Share repurchase: regulatory
environment in India
• Types of Share Repurchases:
– Fixed-price tender offer.
– Book building (Dutch-auction) tender offer.
– Open market repurchase programme.
– Employee stock (issued out of ESOP/sweat equity)
• Shares bought back are to be cancelled and
physically destroyed.
• A company is not allowed to issue fresh shares
within 24 months from the date of buy back
(exceptions apply)
Share Buy-back: SEBI Regulations
• In case of tender offers and offers through book
building , even promoters can participate.
• In case of buy back of shares through stock
exchanges, promoters or persons in control of
the company are not allowed to participate.
• The promoter or person in control of the
company shall not deal in the shares or other
specified securities of the company in the stock
exchange during the period the buy-back offer is
open.
Sensitivity of EPS impact of share repurchase to share
price

I n te r e s t r a te o n d e b t(% ) 8
T a x r a te (% ) 30
E P S S e n s i ti v i ty E x i s ti n g A fte r -r e p u r c h a s e a t R s .
40 100
E a rn in g s 500 4 8 8 .8 4 8 8 .8
N o . o f sh a re s( in m illio n ) 100 95 98
EP S 5 5 .1 5 4 .9 9
E P S R isk 0 .5 0 .5 5 0 .5 3
P /E 8 7 .7 7 2 0 .0 5
 After-repurchase at
EPS Sensitivity Existing Rs.

40 100 200

Earnings 500 488.8 488.8 488.8

No. of shares( in
million) 100 95 98 99

EPS 5 5.15 4.99 4.94

EPS Risk 0.5 0.55 0.53 0.53

P/E 8 7.77 20.05 40.51

Share buy-back: Case of Britannia
Industries
• Operates in bakery industry.
• One of the largest players in the biscuit market in the
country with the sale of over 250,000 tonnes of biscuits
in FY 2003.
• Current Debt-Equity ratio 0.42.
• Intended to buy back (third round) a maximum of up to
2.5 million shares at a price not exceeding Rs.650 per
share payable in cash for an aggregate amount not
exceeding Rs.780 million.
• The buy back size represents 20.09% of the aggregate
of the Company’s paid up capital and free reserves as
on 31 March, 2003 and 9.5% of the paid up equity
capital.
• Mode of buy back: from the open market through stock
exchanges using the electronic facilities of the BSE and
NSE.
Britannia Industries: Rationale for buy
back
• The Company currently has substantial reserves that are
deployed in financial assets that yield below the desired rate
of return for the shareholders.
• The Company believes that it would keep generating enough
cash flows to meet the requirement of the present business.
• Hence, the Company intends to return surplus cash to its
shareholders.
• This offers a reasonably fair exit opportunity to those
shareholders who so desire, in a manner that does not
substantially impact the market price of the Company’s share
to the detriment of the continuing shareholders.
• However, the Company does not anticipate any significant
change in the earnings from its business, except to the extent
of loss in investment income on the amount utilised for
funding the buy back.
 Britannia Industries: Rationale for buy
back

Year Total assets Investments %

March,2000 5205 1469.9 28.24
March,2001 6432.4 2214.4 34.43
March,2002 7486.3 3103.7 41.46
March,2003 7584.6 2968.6 39.14
March,2004 7137.1 3054 42.79
Figures in Rs. Million
Share buy-back: Case of Britannia
Industries
B uy back % o f s h a re sB u yb a c k MP M P (a fte r)
DOA DOC M ode b o u g h t b a c kP ric e /s h a reD O A D O C o n e -m o n thS ix -m o n th
1 0 /1 1 /2 0 0 1 2 7 /1 1 /2 0 0 1 O p e n m a rk e t 3 .5 9 5 3 3 .1 5 5 6 3 .1 5 5 6 5 .6 5 6 1 6 .1 525
5 /9 /2 0 0 2 2 /6 /2 0 0 3 O p e n m a rk e t 9 .3 1 5 2 9 .1 3 5 4 2 .5 5 3 2 .8 5 1 9 .2 5 4 9 .2 5
9 /6 /2 0 0 4 1 5 /0 7 /2 0 0 4 O p e n m a rk e t 9 .9 5 6 3 6 .8 1 5 8 0 6 1 0 .5 5 6 3 2 .4 5 6 7 4 .9
Post-buy back Promoters'

Holding(%)

First buy back 45.34

Second buy
back 48.48

Third buy back 50.96

Rationale for share buy-back:
Reliance Energy
• The buy-back proposal is being implemented in
keeping with the company’s desire to enhance
overall shareholder value. The company has
accumulated free reserves and satisfactory
liquidity. The buy-back would lead to :
– a) reduction in outstanding number of equity shares
and consequent increase in EPS of the company;
– b) improvement in RONW and other financial ratios;
– c) reduction in volatility in the company’s share prices
and lowering of cost of capital;
– d) reflection of the under valuation of the company’s
share price; and
– e) reduction in floating stock.
 Share repurchase: Who gains?
• Post repurchase firm value.
• Full information price.
• Information return
• Tender premium
• Full information premium
 Example on Share repurchase

Consider a firm that has five shareholders: four outside shareholders and one inside
shareholder who controls the firm and does not tender in any buy back programme of the
firm. Assume that each of the shareholders holds 20 of the firm’s 100 outstanding equity
shares and that the current share price is $10.

Now assume the firm proposes a Dutch auction self-tender offer for 20% of the firm’s
outstanding shares at prices between $13 and $17. Suppose the price finally discovered is
$15. The outside shareholders all have the same view of the firm’s prospects and
therefore, each chooses to tender five shares at $15.

Assume that the firm has cash holdings of $500 and has future expected annual after-tax
earnings of $25 in perpetuity. Assume a 5% discount rate for the firm’s risk class.

There is considerable time lag (not less than a month) between the date of announcement
and the date of closure of any buy back offer. To the extent that the market views
repurchases as positive signals conveying insiders’ confidence about the firm’s prospects,
the market will raise its estimate of future earnings during this period- and let us assume
that the new expected level is $38 per annum.
 Why do firms split stock?
• Lowers the cost of a marketable lot.
• Increase liquidity.
• Irrational belief of the investors that the
probability of a price fall is more in case of
highly-priced stock than lowly-priced stock.
• Better signalling effect.
• Empirical favourable evidence.
 Stock Split: Few questions to
answer
• Do you intend to see your scrip trade
within a price band?
• Do you want more marketing support for
your stock from the brokers?
• Do you want more retail investors?
• Should you wait to split?
• Would a split send the right signal?
 Final thoughts
• Dividend pay out.
• Share repurchase.
• Stock Split

– Are they related?

– Should a company take independent view of
each one of them?
– Is this the right way to create long-term
shareholder wealth?