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Buyback - does it benefit Investors ?

Author: Rajiv Singh/Wednesday, January 30, 2019/Categories: Exclusive

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Buyback - does it benefit Investors ?

In the recent past, many companies including government-owned PSUs have chosen to buy back shares held by public and other institutions, instead of paying dividends. At the current juncture, close to 20 buyback offers from various companies are in the pipeline, even as a few companies are considering buyback through open market purchases, while the rest are considering buying back of their shares through tender process. Buybacks have been in vogue for some time now. This is mainly on the back of a few tweaks in certain tax laws which benefit companies that opt for a buyback over paying dividends. This has made buybacks more attractive from both the company’s and investor’s perspective.

A stock buyback is a signal to the market that the business is undervalued and it provides a boost to the company’s EPS. Given that the market assigns very little value to idle cash on a company’s balance sheet, a buyback also boosts its valuation by improving its return ratios. Most of the companies which are in the service industry or companies in sectors with low capital intensity and a large cash pile go for buyback. The rush for buybacks also signals that the companies are failing to find exciting opportunities to reinvest profits in their core business.

Until two years ago, surrendering of shares of a listed company under the tender offer route was considered an off-market transaction and was not subject to Securities Transaction Tax (STT). This implied that any shareholder who tendered his shares in a buyback offer had to pay either short-term or long-term capital gains tax. This compared unfavorably with the existing capital gains tax rules if shares were sold on the exchange. Considering this, SEBI amended the buyback regulations in April 2015.  Due to this, buyback through tender offer announced after July 2015 was allowed to take place through the stock exchanges, which means that STT would be paid on such transactions. As a result of this, long-term capital gains became tax-free, while short-term gains are subject to a tax of 15% (excluding surcharge and cess).

In the Union Budget 2016, it was declared that dividend receipts above Rs. 10 lakh would become taxable at 10% in the hands of investors. When a company declares a dividend, there is already a dividend distribution tax (DDT) on the pay-out. Besides, the dividend is paid out from the net profit, which in itself is arrived at after paying corporate taxes. Budget 2016 imposed an additional tax on dividends (above Rs. 10 lakh) for high net worth investors and made dividend payments from companies unattractive.

However, when a buyback is conducted through the tender offer route on proportionate basis, the profit is treated as long-term capital gains. Even at a long-term capital gains tax of 10%, this works out to be more economical than taxes on dividend pay-outs. For example, if a company decides to return to an investor an amount of Rs. 1 Crore by dividend route, the investor has to pay tax on
Rs. 90 lakh (1 cr – 10 lakh (tax free)), while through buyback route, investor has to pay tax only for the capital gains incurred. Moreover, after the FY2017-18 budget amendment, capital gains are taxed as per price on 31 Jan 2018 and in the current scenario most of the companies which have announced buyback are close to or below the 31 Jan 2018 price. Hence buyback can be assumed as the best process which can benefit shareholders.

Besides these benefits, buyback also act as a price stabilizer at times. For instance, when a company indicates that it is willing to buy back a portion of the equity held by others at a certain price, it generally gives a signal to the market of a likely fair price for the stock. However, it has also been seen in the past that prices of a few companies which came out with buyback offers have witnessed a fall, in a few cases well below the buyback price. In case of dividends, no such signal emanates from the announcement, although dividend yield does act as a support for the stock price. Besides, buybacks also help promoters consolidate their stake in the company, if they don’t tender their shares.

Buybacks may reward the large shareholders (mostly promoters) of the companies than dividend pay-outs, while for retail investors, companies shifting to buybacks in place of dividends isn’t great news as participating in buybacks is more unwieldy than receiving dividends.

As far as buybacks in the PSU arena is concerned, a fiscal deficit which turns higher than budgeted, may prompt the government to push its undertakings to buy back the shares or pay higher dividends. The gap between government’s expenditure and revenues at the end of November stood at Rs. 6.48 lakh crore as against the budgeted Rs. 6.24 lakh crore which comes to around 3.3% of the GDP. Going by the fiscal trend and latest data points, it can definitely be ascertained that the deficit is likely to be breached. There could be more buybacks or dividends in the pipeline, allowing investors to make good returns on dividends and buybacks in the current volatile scenario. This has made buybacks an efficient choice for corporations over dividend payments, especially for promoters who are holding a major chunk of the overall equity. These developments have contributed to a spurt in buybacks and specifically in tender offers (where promoters can participate) in the last two years. About 70% of the buyback offers in the past few financial years have been through the tender offer route. Having said that, it is also important to bear in mind that open market purchase is the most common practice.

To conclude, buybacks provide more tax efficiency for the ultra HNI investors and promoters as they can avoid 10% tax which is imposed on dividend received above Rs. 10 lakh in a financial year. On the other hand, retail investors get the benefit of capital appreciation as the buybacks are always provided at a premium to the current market price and since it is more lucrative for people and institutions that buy and hold stock in bulk, the demand pulls the stock higher. Secondly, the government also gets a route to meet the fiscal deficit targets through buybacks as they are considered proxies to divestments in PSUs. Therefore in a nutshell, buyback act as a price stabilizer for the company as it gives a signal that the management is confident on the business and also provides its fair market value to the market participants.


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1 comments on article "Buyback - does it benefit Investors ?"

Suresh Totlani

2/5/2019 9:10 PM

Buy Back scheme has become difficult for such investors who do not have stock broker. Earlier, it was easy to hand over the 1. Acceptance Form along with Delivery Instruction Slip. NSE should have made two routes. 1. for big investors & 2. easy route for small investors. Thanks.

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