This article is written by Kashish Goel pursuing Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.com.

Introduction

Stock or a share buyback is a practice, when the company decides that they are going to buybacks or purchase their own shares from the existing shareholders. This can be done by purchasing it through the open market or by a tender offer. The price at which the shares are to be bought is at a premium. 

Case of Wipro Limited

It was notified to the public on 13th October, 2020 by Wipro Limited through a public announcement that the Board of the firm has given approval to the proposal of ‘share buyback’ of up to 23,75,00,000 (23.75 crores) equity shares of the company for a price not exceeding Rs. 95,00,00,00,000/- (Rs. 9,500 crore). These shares represent 4.16% of the total equity share capital, for a price of Rs. 400/- each. The closing price as of 13th October 2020 for “Wipro Limited” on the National Stock Exchange (NSE) was Rs. 375.95. 

Now, here is the explanation for the above example.

Here the company “Wipro Limited” decided to buybacks the shares of their own company by a tender offer at a price that was higher than that of the current market price, the market price is Rs. 375.95 and the “Buyback Price” is Rs. 400 that is Rs. 24.05 premium, for a total of 23.75 crore equity shares for not more than Rs. 9,500 Crores. The record date is the date at which the shares must be present in your Demat account. 

Buyback Type:  Tender Offer

Buyback Record Date: 11/12/2020

Buyback Opening Date: 29/12/2020

Buyback Closing Date: 11/01/2011

Buyback Offer Amount: Rs. 9,500 Crores

Buyback Offer Size: 4.16%

Buyback No. of Shares: 23,75,00,000

Buyback Price: Rs. 400 Per Equity Share

History of buyback of shares

In India, earlier the buyback of shares was referred to as the repurchase of shares of their own company. Before 1998 this practice was prohibited by Section 77 of The Indian Companies Act, 1956. But after the Amendment of 1999, the companies were allowed to do so. After this many companies such as Ashok Leyland and Reliance Industries offered to their shareholders to buybacks the equity shares of their own company immediately.

Conditions of buyback of shares

Following are the required condition for buyback of shares;

1. The shares that were bought back are to be discarded, and cannot be reissued. This will reduce the supply of shares in the market.
2. In order to buybacks the shares, the company cannot borrow funds.
3. For the next 12 months, the company cannot issue fresh capital, except bond issue who buybacks the shares
4. This process of buyback can only be done by utilizing the free reserves of the company, that are not specifically earmarked for this purpose.
5. They have to seek approval of the shareholder and the company has to state the amount that they are using for the buyback.

Methods that can be used for buyback of shares

The motive behind this process is to improve the liquidity of its shares and increase the wealth of its shareholders. With SEBI Buyback Regulations, 2018, the company can do this process by which they are permitted to buybacks its shares or specifies securities by the following methods:

• Buying the shares from the employees of the company under the scheme of Employee Stock Option or Sweat Equity;
• The existing shareholders of the company on a proportionate basis; and
• The open market.

The company according to Section 24(vi)(e) has to disclose the change in the shareholding pattern, before and after the buyback.

Objectives for buying back the shares

The response of stock markets to the new details release was quite large both at national and international levels. The buyback declaration and response of stock markets to the same are limited to various aspects, including excess, substitution for cash dividends cash distribution, undervaluation signalling, defence against takeover threat, and the like. The foreign studies and the studies in the Indian context, by and large, documented undervaluation signalling Rajagopalan and Shankar (2013).

• Control

Nobody knows how to run a company better than its promoters, so this method can be used to increase the inside control in firms. In normal circumstances, the insider of a company holder does not reduce their holdings when the company moves forward with the buyback of shares. So, the company ends up holding a larger amount of the reduced equity shares in the market thereby giving themselves more control.

• Debt equity

A firm, who’s debt to equity ratio is very low may or may not use this process to reduce the equity capital so that they can achieve the desired debt to equity mix.

• Direct commitment

Dividend pay-outs are like indirect commitments that you have to do in the future whereas the buyback of shares can be viewed as a one-time exercise. The firm may or may not issue dividends to the shareholders but when a firm announces a share buyback the investor has the option to sell their shares or not. This program is mainly focused on only paying to the shareholders who want it.

• Free cash flow  

The most important reason for a share buyback program is to return the surplus cash, whether the company cannot find any profitable place to invest it. Buying back its shares does reduce the number of shareholders, in turn reducing the number of shareholders who they have to maintain in order to pay dividends. Instead of paying dividend payments to shareholders, they prefer buying back the share and grow.

• Price constancy

Prices of shares in the open market keeps on fluctuating due to the changing market conditions and the periodic bear and bull runs so when the shares of the market shares of the company are undervalued then they can purchase their shares in the beer market and when the price of the share has inflated the management of the company can issue the additional shares to keep the prices in check. So, this facility of buybacks and reissue of shares as a whole affects so that it can moderate the share prices in the fluctuating market which sometimes can be excessive.

• Positive signal

The company will not buy their own shares unless they feel they are undervalued, so when the company buybacks its own shares this gives a positive signal that the management has a commitment to enhance the wealth of the shareholders and expand their operations. This shows how the promoters of the company are confident in the future growth.

• Retained earnings

As per Indian law when a company makes profits they are required to keep some part of that profit in reserves so as when the time comes they meet the financial requirements of the company. So, the portion of the profits is distributed among the shareholders that are retained are called retained earnings.

• Tax advantage

There are some countries in the world where the tax on dividends is higher than that of capital gains. So, the company likes to alternate between the share buyback and the dividend to reduce the burden of tax on the shareholders. Share buybacks are advantageous against the dividend playout as they produce long-term capital gain (LTCG).

Disadvantages of buyback

• Unrealistic picture through ratios

The scheme of share buyback leads to the improvement in the ratios like ROA, EPS, ROE, etc. This is due to the fact that the number of shares in the markets are reduced and not because of the increase in the profitability of the company. Thus giving a picture of an optimistic future that could be away from the ground reality.

• Judgement error in the valuation

It is true that the management has the information regarding the company’s performance, but there can be errors in judging the value of the company. If this scheme of the buyback is carried at a time when the company is undervalued, this means that the future might be overestimated. A mistake here can make the process of the buyback futile.

Requirements for buy-back of shares and specified securities

The applicants to share buyback or any other securities have to fulfil the following condition under the SEBI (Buy-back of Securities) Regulations, 2018, which are as follows:

• Section 4(i) 

The upper limit of any buyback should be twenty-five percent (25%) or less, of the free reserves and the aggregate of the paid-up share capital.

The context to 25% in this regulation, in respect of the scheme of buyback of shares and other specified securities in any of the financial year (FY), implies its total paid-up equity capital in that FY.

• Section 4(ii)

The total of the unsecured and secured debts that are owed by the company after the process is completed should not be more than two times the free reserves and the paid-up share capital.

The government may, by order, notify a higher ratio of the debt to capital and free reserves for a class or classes of companies.

• Section 4 (iii)

All the shares and the other specified securities for the scheme of buyback shall be fully paid up.

Restrictions for buy-back of shares and specified securities

• Section 4(v)

The firm shall not proceed with the process of buyback with a motive to delist the securities or shares from the secondary market.

• Section 4(vi)

The share of any other securities bought in the buyback should not be through negotiated deals, should not be on or off the secondary market, or through any private or spot transactions

• Section 4(vii)

The company cannot make another offer of buyback, until the expiry of 1 year of the previous buyback.

• Section 4(viii)

The company is not allowed to buy back its own shares unless the consequent reduction of its share capital is affected.

Funding of the buyback

• Section 4(ix)
  • Its free reserves
  • The securities premium account
  • The proceeds of the issue of any shares or securities as specified

It is also provided that no buyback can be made out of the proceeds of an issue which was earlier for the same kind of shares or the same kind of securities. 

The procedure of buyback of shares in India

After meeting the requirements and conditions laid in the SEBI Buyback Regulations 2018, the company can move forward toward the following procedure;

• Step 1: Call a board meeting

Here the applicant is required by the law to call a board meeting and the notice for the same has to be served before 7 days (at least) of the meeting.

• Step 2: Approval for extra-ordinary meeting (EGM)

In the board meeting called, the approval of buyback has to be passed and the date of EGM is to be fixed along with the approval of EGM’s notice with the explanatory statement u/s 102.

• Step 3: Sending notice for EGM

This notice is to be sent 21 days prior to the EGM, but, after the approval of the motion of EGM

• Step 4: A special resolution for buyback of shares

The resolution of the buyback is needed to be passed in this EGM.

• Step 5: Filing SH-8

One must file a Letter of Offer with the Registrar when the resolution for the buyback is passed. This letter must contain the signatures of the two directors of the company.

• Step 6: Declaration of solvency

Along with step 5, one needs to file a form SH-9, which is the declaration of solvency. This form also requires the signature of two directors.

• Step 7: Letter of an offer to the shareholders

Once the filing of SH-8 is done with the registrar, within 20 days the letter has to be dispatched. This letter needs to be kept open for a period of 15 to 30 days.

• Step 8: Acceptance of offer

In order to object to a rejection, the shareholders need to send a communication within 21 days of offer closure.

• Step 9: Opening of a bank account

If all the resolutions are passed and no objections are made, the company opens a separate bank account where they would deposit the consideration of buyback. The consideration is to be paid within 7 days of verification and the shares acquired are to be destroyed within 7 days of the completion of buyback.

• Step 10: Filing of SH-11

This has to be filed within 30 days of the completion of the buyback. (For a detailed procedure)

Objections of share buyback

• Biased advantage

A company buyback of shares may make a bargain purchase that gives an imbalance advantage to the continuing, non-selling, shareholders.

• Manipulation

The managers may resort to manipulation of the shares if the companies were allowed to buyback of shares. True depressed prices, conclusive trading create anxiety among investors, in turn, they square off their position to the company by making apparently too good to pass offers. 

• Excessive payment

This may end up costing too much for the company. These schemes of share buyback and other securities are generally may or may not be motivated by the desire of the promoters who wish to raise their stake in the company at the expense of the non-promoter shareholders

Impact of share buyback

It is the belief of the management that a scheme of work will be beneficial for the company and the shareholders financially. If the company distributes surplus cash or free cash flow and it maintains its operating efficiency, EPS will improve. The share price of the company will be better as compared to the price-earnings ratio as expected to be the same after the buyback. Due to the reduction in the equity capital, the debt to equity ratio will also improve. This will enable the forms that have a low debt to equity ratio to move their target capital structure.

Recent buybacks in India 

Conclusion

India the scheme of buyback has been amended to sustain the economy and allow companies to retain their place in the stock market. After the amendments of 1999, the major governing laws were made regarding buyback and many companies announced buyback in the capital market of this country. Within the year of this amendment, many companies have started to repurchase their shares and it has been increasing over the year ever since. There have been more than 200 buyback announcements since the implementation of the buyback of shares, which was done by the various companies in the Bombay stock exchange by various methods, mostly through an open offer.

The share buyback program is a positive thing that was added after the 1999 amendment because it provides various advantages like that of return of surplus cash the shareholders per increase in the share value, the undervalued share price is recognised the capital structure of the company is improved by reducing the outstanding shares and it also helps the company save tax. It has various disadvantages such as overvaluationis by a company, unrealistic pictures through ratios, judgement of error in the valuation. Overall it’s a positive thing for a company and if done correctly it will improve the growth because the money the company would normally use for giving out dividends will be saved over the years and used in the growth of the company in turn increasing the wealth of shareholders.

References

• https://www.business-standard.com/article/news-cm/infobeans-tech-soars-after-board-oks-rs-10-cr-buyback-121042600471_1.html

• https://www.business-standard.com/article/news-cm/board-of-insecticides-india-approves-buyback-of-shares-up-to-rs-60-cr-121033100191_1.html

• https://www.ndtv.com/business/stock-updates-aarti-drugs-set-to-open-share-buyback-offer-on-april-27-2418512

• https://www.businesstoday.in/current/corporate/infosys-approves-rs-9200-crore-buyback-at-rs-1750-per-share/story/436616.html

• https://www.thehindubusinessline.com/markets/stock-markets/quick-heal-board-fixes-record-date/article34369839.ece
• https://www.indiatvnews.com/business/markets-niit-share-price-buyback-price-record-date-2021-694951

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