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What can you expect from the Infosys buyback?

Author: JK Jain/Tuesday, August 29, 2017/Categories: Corporate

What can you expect from the Infosys buyback?

There has been roaring talks on the street in relation to buyback offers. Recently, IT bellwether Infosys announced a mega buyback worth Rs 13,000 crore. It is interesting to note that the buyback is at Rs 1,150 per share. Share buyback is not a recent phenomenon, but as a retail investor, you must have wondered why a company wants to buy back its shares and what you should do to reap maximum benefits. Here is a low-down on buybacks and the ground realities.

What do you mean by buyback ?

Share buyback means re-purchase of shares by a company to reduce the number of shares trading in the market. Market experts believe that it usually shows the confidence of promoters in the future of the company. There are a number of reasons why companies go for buybacks. Companies go for buyback in cases where they want to reward investors, increase promoter holding, reduce public float and check the falling stock price, reduce volatility and build investor confidence.

There are many ways in which owning shares of publicly-listed companies can generate wealth; most typically it is through stock price appreciation. Two other important forms of wealth generation include dividends and stock buybacks. Highly successful companies can sometimes reach a position where they are generating more cash than they can reasonably reinvest in the business. During the financial crisis of 2008, investors pressured companies to distribute their accumulated wealth back to their shareholders, and this practice has not stopped. Now, instead of traditional dividend payments, buyback strategies are quite popular as they are seen as a tax advantageous way of returning excess cash flow to investors. Buyback of share from the public can also be done if promoters want to hike their stake in the company, sometimes to avoid any takeover threats.

What is triggering buybacks in 2016-17?

In the recent past, many IT firms have offered buybacks due to lack of options for acquisitions and historic low valuation of their share prices. These companies are facing major slowdown and have accumulated high cash in their books; so share buyback is a healthy way of rewarding shareholders. Secondly, share buybacks will also improve financial valuation parameters of the IT firms as they are going through a rough phase of business growth due to factors such as falling software exports, pricing issues and the appreciation of the rupee. Here are three major key triggers that lead to share buybacks:

  1. Surplus cash: Surplus cash with less meaningful deployment options is the prime reason for share buybacks. Typically one can analyze, how cash-rich companies are returning cash through buybacks, as they reward shareholders besides paying dividends.
  1. Undervalued stock: When a company believes its current share price does not reflect its true value, it can buy back its shares, which increases its EPS and, hence, the share price. A buyback, in such cases, signals to investors the company's confidence in its business and future prospects. It also increases the promoters' stake, assuming they did not participate in the buyback.
  1. Tax advantage: Buybacks have gathered momentum after the Union Budget 2016-17, where the government imposed an additional 10% of tax on dividends for all individual shareholders (including HUFs) and partnership firms (also extended to private trusts in FY18 Budget) whose dividend income exceeds Rs 10 lakh in a financial year which is over and above the DDT paid by the company concerned. According to the Income Tax Act, share buyback would not attract dividend distribution tax if it is within the provisions of the Companies Act, thereby allowing companies to save crores of rupees in taxes.

Modes of buyback:

According to buy-back norms laid out by SEBI, there are two ways in which a listed company can go about repurchasing its shares from existing shareholders, namely:

  1. Open market purchase: If a company opts to buy shares from the open market, it makes an offer to shareholders indicating the max price and the number of shares it wishes to purchase. However, the company is at liberty to pay less than the initially offered price and is not obligated to purchase the entire quantity as announced in the repurchase plan. Only public shareholders are permitted to participate in the open market buyback.
  1. Tender route: Here the company directly purchases shares from the shareholders on a proportionate basis. The biggest plus is the company fixes the price at which it intends to buy the shares, which are generally higher than the market prices, thereby benefiting shareholders. Both promoters as well as public shareholders participate in the process.

What is special in the Infosys Buyback ?

Let us understand the buyback dynamics of Infosys. The company is planning to buy back 11.3 crore shares at Rs 1150 a piece. The SEBI has mandated companies to set aside 15% of the total buyback size for retail investors, or those holding shares worth up to Rs 2 lakh on the record date – the cut-off date to decide which shareholders are eligible. Which means, Infosys will have to set aside Rs 1,950 crore to buy shares from retail investors whose allocation for small shareholders works out to 1.7 crore shares (15% of the total buyback shares).

Now, there are broadly four variables in this exercise to come to the conclusion:

  1. What quantity of holding will qualify as small shareholders: As per our understanding, to qualify as a small shareholder, the value of holding should not exceed Rs 2 lakhs on record date. So this will be around 175 shares per investor as the buyback price is fixed at 1150 per share.
  1. How many such small shareholders will Infosys have on the record date: The other key variable is the number of small shareholders of the company on record date. As per the annual report of Infosys, the number of shareholders owning up to 200 shares in the company is close to 2.87 crore. However, depending on the price, this number can go up (for instance, if the price is Rs 900 then a quantity of 222 might qualify). In addition, because of the possible gains from the offer, there might be additional buying that could add to the number of small shareholders.
  1. How It Is Different from Acceptance Ratio: Acceptance ratio is the proportion of shares accepted to the total number of shares tendered in the buyback by investors, including promoters. Acceptance ratio is generally lower if a higher number of eligible investors tender shares. But it cannot be less than the entitlement ratio. Recent buybacks of companies like Bharti Infratel, Mphasis and Tata Consultancy Services Ltd. saw an acceptance ratio of 100% as the promoter holdings were high and all the shares tendered were accepted.

Possible gains from the buyback for the retail Investors:

Below is the detailed table explained to derive the possible gains to the retail investors assuming Rs. 900 to be the share price on the record date with acceptance ratio of 60, 80 and 100% ratio. We expect the acceptance ratio to be around 60% in the current buyback.

Particulars

Scenario -1

Scenario -2

Scenario -3

Acceptance ratio

60%

80%

100%

No of Shares tendered

100

100

100

Accepted @ buyback

60

80

100

Amount Received by buyback @ Rs. 1150

69000

92000

115000

Current  Market Price (Assumed)

900

900

900

Shares sold in open market

40

20

0

Amount Received from open market

36000

18000

0

Total Amount Received

105000

110000

115000

Total Return post buyback

15000

20000

25000

% Return post buyback

16.67

22.22

27.78

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