Share Buyback
What is Stock Buyback and how does it benefit the shareholders?
A Share Buyback is a technique used by companies to purchase their own shares from the existing investors. After the shares have been acquired, these are usually cancelled and this reduces the number of shares of the company that are trading in the market.
The present investors of the company get an option to sell their shares, but it is not mandatory for them to sell. A Buyback is a method for rewarding the shareholders and the company does the purchase by using the Retained Earnings and excess cash that it holds.
An Equity Buyback is usually done when the company feels that the market price of the stock is lower than the actual value of the stock. There are primarily 2 ways in which the companies can complete the buyback of shares:
- Tender Offer
- Open Market purchase
Tender Offer
In case of a Share Buyback through Tender Offer, the company will give an option to the investors to sell their shares at a fixed price to the company. An Offer Period is notified, during which the investors can submit their Tender Forms to the company.
Depending on the number of shares owned by the investor, the company will also notify the Entitlement Ratio to each investor. This ratio will indicate the minimum number of shares that the company is guaranteed to buy from the investor (if he/she is willing to sell).
Example: Suppose that an investor holds 250 shares in the Demat Account and the company announces a Stock Buy Back with an Entitlement Ratio of 1:25 (1 share repurchased for every 25 shares owned). This means that the company is committing to buy at least 10 shares from this investor.
Working of Tender Offer
In this section, we will try to give a high-level overview of the entire process for Stock Buybacks through Tender Offer.
Step 1: The company announces the details of the Stock Buyback, which includes the important dates, Offer Price, Entitlement Ratio etc.
Step 2: On the Record Date, the company identifies the eligible shareholders and the number of shares owned by these shareholders. So, in order to participate in the Share Buyback, the investors need to purchase the shares on or before the Ex-Date for Buyback.
Step 3: An open and close date for the Tender Offer is usually notified at the beginning of the process. In this duration, the investors can submit the application/Tender Form, to sell their shares.
Step 4: After receiving all the applications, the subscription status of the Shares Buy Back is checked. Based on the Entitlement Ratio and the number of shares that have actually been tendered for sale, the company finalizes the Buyback Acceptance Ratio.
Step 5: The Acceptance Ratio is notified and the company will inform about the number of shares that it will be purchasing from each investor that offered his/her shares for sale. The investors who did not offer their shares, will not be impacted because the company will not purchase the shares from them.
Step 6: The accepted number of shares are debited from the Demat Account of the eligible investors and cash payment is made to the Bank Account of these investors for their sold shares.
Step 7: After collecting all the shares from the investors, the company will extinguish the shares and this will reduce the total number of shares of the company in the market.
Open Market Stock Repurchase
In case of Share Buybacks through Open Market, the company will simply buy the shares through the Stock Exchange (or Over The Counter, for unlisted shares). This is a continuous process in which the company will regularly purchase the shares for few weeks/months.
Since there is an additional buyer in the market, the stock price will tend to move up and it gives an opportunity to the investors to sell their shares in the market. This method is different from the Tender Offer route because the purchase price is not fixed before-hand.
The companies will actively buy the shares at the available Market Price and only notify a maximum price at which it will stop buying. At the end of the purchase period, the company will cancel all the shares that were purchased from the market.
Important dates in Stock Buyback
Depending on the process that is used by the company for performing the Buyback, there will be different dates that will be notified. When a Share Buyback is being done through Open Market purchase of shares, the company will notify a start and end date for the Buyback. In this duration, the company will be performing the buy transactions in the market, at regular intervals.
Any investor who wishes to sell the shares can sell in the market at any time (even before and after the Buyback Period). On the Stock Exchange, it is not possible for the seller to know who is the buyer. So, it is not necessary that the shares sold by every investor will be directly purchased by the company.
During the Share Buyback Period, the company will daily notify the Stock Exchange about the summary of shares bought on that day (Refer: How to check corporate announcements of your shares). After the end date, all the shares acquired by the company will be extinguished and this will reduce the Free Float of the company.
Important dates in Tender Offer
In case the Share Buyback is done through a Tender Offer, then the investor would need to be aware about the following important dates: Record Date, Ex-Date, Offer Open and Close Date, Shareholder Finalization Date, Settlement Date and Share Cancellation Date.
The Record Date is the day on which the company will generate the list of investors who are eligible to submit the Tender Offer in the Buyback. So, if a shareholder wishes to participate in the Tender Offer, then he/she should own the shares of the company on this particular date.
The Ex-Date will communicate the cut-off date for the investors to buy the shares. To get the ownership of the shares in time for the Record Date, the investor needs to purchase the stock before the Ex-Date.
Between the Offer Open and Close Date, the eligible shareholders can notify the company about the number of shares that they wish to sell. After all the applications have been received, the company can finalize the investors from whom the company will buy.
Depending on the Acceptance Ratio, the investors will receive the information about the number of shares that the company will be buying from them. On the Settlement Date, the shares are debited from the Demat Account of the investors and payment is subsequently transferred to the bank account of the investor.
Once all the shares have been collected, these will be extinguished by the company on the Share Cancellation Date. These shares cannot be traded anymore and the Balance Sheet of the company is also adjusted.
Impact on shareholders
There are multiple benefits for the shareholders when a company is conducting a Share Buyback. Since the repurchased shares are extinguished by the company, a major benefit of a Buyback is that the shareholders can increase their ownership interest in the company, if they do not sell.
It is not mandatory for the investors to sell their shares in a Buyback. If an investor is holding on to his/her shares while others are selling it back, then the ownership interest of this investor will increase.
Example: Let us assume that a company has a total of 80,000 shares in the market. Out of these, suppose that 4,000 shares are owned by Investor A and remaining 76,000 are owned by others. This translates into an ownership of 4,000 / 80,000 = 0.05 or 5 % for Investor A.
Now, let us assume that the company buys back 8,000 shares from all the investors and cancels them. The new number of shares of the company will become 80,000 – 8,000 = 72,000. Depending on the number of shares sold by Investor A, his/her new ownership interest will be as follows.
Case 1: Investor A sells 0 shares and others sell 8,000 shares
Investor A will now own: 4,000 / 72,000 = 0.0556 or 5.56% shares of the company.
Case 2: Investor A sells 400 shares and others sell 7,600 shares
After the Buyback of shares, Investor A will own: 3,600 / 72,000 = 0.05 or 5% shares of the company
Case 3: Investor A sells 1,000 shares and others sell 7,000 shares
Investor A will now own: 3,000 / 72,000 = 0.0417 or 4.17% shares of the company.
Exit option for large shareholders
Another benefit of Share Buy Backs is that the large shareholders in the company get a chance to liquidate huge number of shares in a short time. If any investor suddenly starts selling large quantities of shares in the market, then the stock price will move downwards.
This can become a challenge for shareholders who have a big ownership in the business. If a Share Repurchase is being done by the company, then such investors can offload large quantities of shares, without sacrificing much on the price.
As already explained in the above section, these shareholders can also preserve (or increase) their ownership, by holding on to their shares while others are selling in the Buyback.
Impact on financials of the company
As mentioned before, a Share Buyback is a technique for the company to directly reward the shareholders. As shares are bought from market, the stock price tends to move upwards and the ownership percentage will increase for those who do not sell their shares.
But giving out these benefits is not free for the company because it requires funds to buy these shares from the market. So, companies will usually utilize the surplus funds and the Retained Earnings for the Stock Buy Backs. Once the shares have been purchased and extinguished, the Equity Share Capital of the company will decrease.
Example: Suppose that a company has 50 crore (50,00,00,000) Fully Paid-Up shares and each share has a Face Value of INR 2. So, the Share Capital of the company will become: INR 100 crore. Let us assume that the Balance Sheet of the company is as follows.
|
Assets |
Value (INR crore) |
Liabilities |
Value (INR crore) |
|
Cash |
90 |
Equity Share Capital |
100 |
|
Current Assets |
170 |
Other Equity (Reserves and Surplus) |
140 |
|
Non-Current Assets |
160 |
Other Liabilities |
180 |
|
420 |
420 |
Now, let us suppose that the company declares a Share Buyback through a Tender Offer and the details of the Buyback are as follows:
Offer Price: INR 20
Number of shares to be bought: 1 crore (1,00,00,000)
For the company, this would mean the following things:
Total cash spent on Buyback: 1 crore * INR 20 = INR 20 crore
(This excludes other expenses for conducting the Buyback)
Share Premium paid per share: INR 20 (Offer Price) – INR 2 (Face Value) = INR 18
Total Share Premium paid: 1 crore * INR 18 = INR 18 crore
Since the Face Value of the shares is INR 1, the change in the Equity capital can be calculated by multiplying the Face Value and the number of shares purchased. So,
Decrease in Share Capital: 1 crore * INR 2 = INR 2 crore
After the Equity Buyback is complete, the Balance Sheet of the company will appear something like this:
|
Assets |
Value (INR crore) |
Liabilities |
Value (INR crore) |
|
Cash |
70 |
Equity Share Capital |
98 |
|
Current Assets |
170 |
Other Equity / Reserves and Surplus (Share Premium Account) |
122 |
|
Non-Current Assets |
160 |
Other Liabilities |
180 |
|
400 |
400 |
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