BackWhen to hold or sell shares during buyback offers
Should you give up your shares or hold on to them during a buyback offer?
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Tata Consultancy Services Ltd earlier this week announced its Board’s approval to buy back shares worth Rs16,000 crore at Rs2,850 per share. This is a premium to the market price. If you hold shares of TCS, you may want to know more about buybacks and whether to give up your shares or hold on.
The concept is simple: it’s when a company uses its own cash to buy shares from the public. It is somewhat the opposite of an initial public offering (IPO). Once the shares are bought back, they get absorbed and cease to exist. In this case, TCS is buying back shares that account for around 2.85% of the total paid-up equity capital of the company.
There are various reasons why a company may attempt a share buyback. A common reason is a large cash surplus in the balance sheet. Ideally, too much cash on books is not considered financially healthy as it shows inefficiency in utilizing assets. A business needs to utilize its cash either to grow its capacity or grow inorganically through acquisitions. Cash that is not being reinvested is being under-utilized. A buyback is one way to make use of this surplus.
There are other reasons, too, for a buyback. The company may be reducing some of its dividend liability by buying back shares and reducing cost. Second, it could be a signal that there aren’t any worthwhile investment opportunities for the company to increase capacity or through acquisitions.
Keep in mind though that buying back shares can improve the overall earnings per share as the number of shareholders reduce, but fundamentally the value of the business remains unchanged. There could be an accounting impact on financial metrics like return of equity, which measures the earnings, or net profit generated per rupee of equity capital, but that should not be seen as a reflection on the business operations.
Another reason is when a company feels the market value of its shares is below the discounted fair value. A buyback in such cases signals that the company itself is confident of its business and potential future value to investors.
You have to consider the price of the buyback. If the price is at a premium to the market price, a buyback can be an attractive opportunity.
In the TCS buyback, the offer is priced at Rs2,850 per share when the current market price is around Rs2,505—nearly a 14% premium.
This is not an easy decision to make. If the premium price of a buyback is intended to signal a belief that the stock is undervalued and one assumes that the management will continue to work towards improving shareholder value, then it may be better to remain invested, especially if you are a long-term investor. In the coming years, one could see better value for the shares.
Tendering to a buyback makes more sense if you feel the share price in the market is overvalued, or you don’t believe there are opportunities to grow earnings at the same pace going forward.
For long-term retail investors, taxation is neutral as buybacks are now done through stock exchanges using the securities transactions tax and they are not subject to capital gains tax.
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