De-jargoned: Buyback vs open offer3 min read . Updated: 25 Dec 2020, 10:05 AM IST
- This financial year, buybacks were mostly done to reward shareholders. Buybacks are voluntary unlike open offers which are automatically triggered based on Securities and Exchange Board of India (Sebi) guidelines.
Since Tata Consultancy Services Limited (TCS) intimated that exchanges that it plans to buyback shares, the stock price has been rising. On October 7, the day of intimation, the stock price was ₹2,737.4. On December 24, it closed at ₹2,908.45.
The company had announced that the buyback will be at ₹3,000 apiece.
The tendering of shares started on 18 December and will close on 1 January. The company is buying up to 5.33 crore shares for ₹16,000 crore. According to its letter of offer “the actual buyback entitlement for reserved category for small shareholders is 41.05%".
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It means, out of every 10 shares held by a small investor, the company could accept about four shares. “In a buyback, a company could accept a higher or lower number of shares depending on the response to the offer. The number of shares that will be accepted is not guaranteed," said Venu Madhav, chief of operations, Zerodha, a stockbroker.
Small shareholders are those who hold shares worth up to ₹2 lakh.
Wipro had also announced buyback, which will start from 29 December and close on 29 January.
In their letter of offer, both the companies stated that the reason for buyback is to return excess cash to shareholders.
Shareholders get similar opportunities when there’s an open offer. But the trigger for the two are different. Let’s look at the difference in detail.
Buybacks are becoming popular of late as the government had introduced dividend distribution tax (DDT) when a company pays dividends. “A shareholder pays dividend tax based on his applicable slab rate. However, the company deducts tax at source. In the case of a buyback, the company is taxed whereas it’s tax-free for shareholders," said Suresh Surana, founder, RSM India, provider of audit, tax and consulting services.
This financial year, buybacks were mostly done to reward shareholders. Buybacks are voluntary unlike open offers which are automatically triggered based on Securities and Exchange Board of India (Sebi) guidelines.
Sometimes, companies use buybacks to boost confidence in investors when markets are weak, and their stock prices take a hit. Buybacks support stock prices in such a scenario and send a signal that the management believes that companies were undervalued.
For investors, buybacks are an opportunity to make profits. Typically, the buyback prices that companies announce are at a premium to the prevailing stock price. The stock price, therefore, rise after the buyback announcement. But investors should remember that once the buyback is over, the stock price usually sees a correction.
As companies usually take a limited number of shares, there is always the option for investors to sell in the open market when the price starts to rise. They should also avoid arbitrage of buying in the open market after the buyback announcement and tendering it in the open offer.
The number of shares that a company would accept is unpredictable. It depends on the response to the offer. There are even cases when the companies shelve the buyback plan.
An open offer is triggered in two cases only. First, when another company or investor buyers 25% stake in the business. Earlier it was 15%. In such a scenario, the acquirer must give an open offer to shareholders and acquire 20% more shares.
In the second scenario, an open offer is triggered when promoters or parties acting in concert with the promoters acquire more than 5% stocks in a financial year. In such a scenario, the promoter must give an open offer to shareholders and acquire 20% more. “The 20% limit is applicable only if promoters’ stake remains under 75%," said Surana.
While both offer opportunities for investors to make profits, it’s best to avoid investing in stocks when buybacks or open offers are announced to make a quick buck as it could be risky.