For stock market participants, the most interesting and common thread of discussion currently is that of buy-back offers and how investors can profit from some of the mega offerings that are scheduled to hit the market in the near future.
Tata Consultancy Services (TCS) has already said that it plans to buy back up to 5.61 crore equity shares at a price of ₹2,850 per share. The offer size of ₹16,000 crore makes it the largest buy-back offer till date in India, surpassing the ₹10,400 crore offer by Reliance Industries Ltd (RIL) in 2012.
Sector heavyweight Infosys has also initiated the process to amend its Articles of Association (AoA) to include the provision for a buy-back as mandated by the new Companies Act.
The postal ballot notice sent to shareholders for approval states: “Power to purchase its own equity shares or other securities by way of a buy-back arrangement has been included and provisions relating to nomination facility for shares by a shareholder have been inserted.”
Market participants are of the view that Indian software majors should look at buy-back offers since they have large cash reserves and, at a time when business is showing signs of slowdown, it would be a good exercise to keep shareholders happy by way of such offers.
IT is the sector
“Significant net cash, low capital intensity and cash generative nature of business, softening interest rates, slowing growth and low trading multiples make a strong case of buyback for Indian IT (information technology),” said a recent report by Jefferies, a foreign brokerage.
“Recent announcement at Cognizant sets a good precedent with Indian tax rules making buy-backs more efficient than dividends. The long-term benefits to RoE/EPS (return on equity/earnings per share) is evident from Accenture’s example. TCS and Infosys have the maximum firepower for buy-backs within Indian IT,” added the report.
TCS has a cash and cash equivalent balance of close to ₹38,000 crore, as per the financials for the quarter ended December 31, 2016. Infosys reported a balance of ₹32,697 crore at the end of the financial year 2015-16. For Infosys, the cash balance had steadily increased from ₹25,950 crore in FY14 to ₹30,367 crore in FY15.
Interestingly, Jefferies was of the view that among Indian IT majors, only TCS and Infosys can undertake large buy-backs given their cash pile. It said that other IT majors in India have a much smaller cash pile and that their inclination towards inorganic growth - or mergers and acquisitions - may make such offers from them less likely.
“Of the Top-5 Indian IT companies, we believe TCS and Infosys are the only ones likely to do a larger buy-back, up to 25% of the net worth. Wipro, HCL Tech and Tech Mahindra’s lower levels of cash and a higher focus towards inorganic growth might limit the extent of the buyback in their case,” it says.
Incidentally, the board of NASDAQ-listed Cognizant has approved a plan to return $3.4 billion to its shareholders over a period of next two years through buy-backs and dividends. NYSE-listed Accenture Plc has a history of returning all it profits to its shareholders in the form of buy-backs and dividend payouts.
Unlike Cognizant, Indian companies are only likely to use existing cash with no commitment of future cash flows yet and extremely unlikely to use debt to fund buy-backs, says Jefferies.
Who gains?
Does the shareholder gain or the company in a buy-back, is the oft-asked question from investors. Simply put, the two are intertwined since it’s the shareholder that gains if the company does well in terms of better profitability and earnings upgrade.
In a report released February 8, global financial major BNP Paribas said that large and mid-sized Asian companies with a market capitalisation of more than $1 billion that bought back more than 10% of their equity since 2009, a majority had upward revisions in earnings estimates after the buyback announcements.
In the case of a buy-back, since the equity shares that are bought back are extinguished, the company’s financial metrics including earnings per share (EPS) and return on equity (RoE) typically improve.
Incidentally, in the case of TCS since the maximum buy-back size represents a mere 2.85% of the equity capital of the company, it is believed that the value accretion would not be significant though it would be too early to predict any possible earnings upgrade by the analyst community.
A management team typically plans a buy-back when it feels that the company shares are under-valued or, in other words, do not reflect the true fundamentals of the entity. Studies have shown that buy-backs have led to significant upgrades in the EPS in the near- and medium-term.
“In Asia, ex-Japan, 35 companies with a market capitalisation of at least $1 billion have cumulatively bought back 10% or more of their average outstanding equity since 2009. We measure their 1-year forward EPS change from their first buy-back date over one month, three, six, and 12 months... Our research reveals that such management perception is by and large correct, but the earnings estimate upgrades don’t happen immediately,” wrote BNP Paribas in the report.
While Indian companies can opt for either buy-back or dividends to reward its shareholders, the former choice scores in terms of lower tax burden. While there is no additional tax in a buy-back, dividends come at a cost since there is a dividend distribution tax of more than 20% on the companies while individuals have to pay 10% tax if dividend received is more than ₹10 lakh.
Indian companies like Cairn India, Bharat Electronics, Piramal Enterprises, Bayer Cropscience and National Aluminum, among others, have opted for buy-backs in the recent past.
India, Asia, World
There is an increasing trend among Indian companies to use the buy-back route to reward shareholders. Data from Prime Database shows that the current financial year saw 33 buy-back offers amounting to ₹28,460 crore – the highest in any fiscal till date.
Still, on the global map it is too little to catapult India to the top league. As per BNP Paribas, barring companies in Japan, Asian companies are not known for their buy-back penchant (see table).
“North American and European companies have bought back more shares (in U.S. dollar terms) in each of the past five years, than Asian companies have done in the past decade. Japanese companies, on the other hand, buy back almost double the quantum that Asia ex-Japan companies do,” it says.
Interestingly, the BNP Paribas report that was released much before TCS and Infosys announced their buy-back plans, mentioned both the IT majors as part of its “potential buy-back basket.”
