What is it
When a company wants to buy its own stock from the shareholders, it is known as a share buy-back.
Why companies want to buy their own shares
Companies typically buy their own shares for various reasons. The main impact of reacquiring shares is that the supply of stock in the open market reduces, which acts as a support for the price. It is a sign that the company is confident about its prospects.
For example, Reliance Infrastructure Ltd’s board on 14 February approved a proposal to buy back shares of up to Rs 1,000 crore. A company statement said it is doing so to “reduce short-term volatility” in share prices and “reiterate the confidence of management in future prospects”.
Also companies at times buy back shares to ward off hostile takeovers. Fewer shares floating in the market would mean that a predator will find it difficult to buy enough shares to launch a takeover bid. Companies also buy back shares if they have surplus cash that is not needed for business and want to reward their shareholders. They make an offer to buy back shares at a considerably higher price than the existing market price.
How is it done
The company has to first get approval from its board and then it can buy back shares either through a tender offer or through the open market.
In a tender offer, the company offers to buy stock from shareholders at a declared price for a specific period of a fortnight. For example, Piramal Healthcare Ltd had announced to buy back up to 41.8 million shares at Rs 600 apiece between 17 January and 8 February.
The second method is open market purchase. Here the company announces a price and says its will accept applications to acquire shares till it reaches the limit set by its directors. Unlike a tender offer, the duration of the buy-back is not restricted to a fortnight and can go on for up to a year.
For instance, Reliance Infrastructure Ltd has said that it will buy its shares at Rs 725 each and will do so till it exhausts the Rs 1,000 crore limit set for the purpose.
Is it compulsory for investors to accept the offer?
No. The decision is entirely yours. You should consider factors such as the number of outstanding shares of the company, the future prospects, the reason for such a buy-back, percentage of shares you offer that would be accepted by the company before taking a decision.