A Better Share

Rahul Oberoi/Money Today        Print Edition: March 2012

The year 2012 started with shopping news of a different kind-share buybacks . First, the market regulator, the Securities and Exchange Board of India (Sebi), changed the process and mandated that companies buying back own shares should declare the buyback ratio, as they do in rights issues, and fix a record date. Buyback ratio is a market valuation measure used to gauge what percentage of market value is being reduced by the share buyback activity.

Four per cent is the return given by the RIL stock between the announcement and start of buyback

Second, Sebi approved changes in rules to allow public sector units (PSUs) to buy back shares. As a result, shares of PSUs such as MMTC, Hindustan Copper, State Trading Corporation of India and Dredging Corporation of India rose 30-50 per cent in the first five trading sessions of January. However, on January 6, the Union cabinet deferred the decision due to differences among ministries.

Third, on January 20, Reliance Industries, or RIL, approved buyback of up to 120 million shares at a price not exceeding Rs 870 per share. The stock has risen 4 per cent since despite the company reporting poor numbers for the third quarter. It was at Rs 830 at the commencement of the buyback on February 1.

Why did shares of RIL and PSUs rise on buyback news? Varun Goel, head, equity portfolio management services, Karvy Private Wealth, says, "A buyback is done to send a signal to the market that the company believes the stock is trading below its intrinsic value."

PERSPECTIVE: Behind RIL's share buyback move"Shares react positively to such announcements because buyback reduces the number of shares outstanding, which increases investors' claims on dividends and earnings of the company. As these claims increase, so do stock prices," says Samir Gilani, head, derivatives, and co-head, equities, MAPE Securities.

However, Goel says, "A buyback may create a short-term spike that may not last. Most of the times, it is perceived as a vote of confidence in the company. However, in some cases, a company may buy back shares to delist."

Share buyback means purchase of outstanding shares by a company to reduce the number of shares trading in the market. Market experts say it usually shows the confidence of promoters in the future of the company.

Pavan Kumar Vijay, managing director, Corporate Professionals Group, says, "There are a number of reasons companies go for buybacks.

The intention is to reward investors, improve financial ratios (such as price to earnings, return on assets and return on equity), increase promoter holding, reduce public float and check the falling stock price, reduce volatility and build investor confidence."

Some common buyback routes companies take are tender offer and open market purchase. In tender offer, the company makes an offer to buy a certain number of shares at a specific price directly from shareholders.

Brijesh Parnami, chief executive officer, distribution, Destimoney Enterprises, says, "This route ensures all shareholders are treated equally, however small they are." In open market purchase, the company decides to acquire a certain number of shares. It fixes a price cap and can buy for any price up to that.

"Most companies prefer the open market route. The biggest difference between the two is that the price in the tender route is fixed," says Parnami.

A buyback usually improves the confidence of investors in the company and so its stock price rises. However, past data reveal the stock can move in either direction after the buyback announcement, though it helps stocks in most cases (See Stock Moves).

For instance, out of 500 companies in the BSE 500 index, 14 bought back shares in 2011. These include Zee Enertainment Enterprises, CRISIL, Reliance Infrastructure, Rain Commodities, Onmobile Global, Monnet Ispat & Energy and Amtek Auto. Of these, share prices of eight rose between the announcement date and the day the buyback started. Onmobile Global, for instance, rose as much as 19.9 per cent during the period.

Four per cent is the return given by the RIL stock between the announcement and start of buyback

On the downside, share prices of Deccan Chronicle Holdings (DCHL), Jindal Poly Films, Amtek Auto and Praj Indusries, Balrampur Chini and FDC fell 32.2 per cent, 24.4 per cent, 16.6 per cent, 7.6 per cent, 6.1 per cent and 5.2 per cent, respectively.

"The obvious reason for the fall is the mismatch between the buyback price announced by the company and investor expectations," says Pankaj Pandey, head of research, ICICIdirect.com.

However, Vijay says, "The price trend depends on various factors such as the market situation, the mode of the offer, that is, tender or market purchase, the size of the offer, the difference between the offer price and the market price of the stock and the market's confidence in the management's intention to carry out the offer."

On 27 May 2011, PVR announced an open market purchase of its shares on the Bombay Stock Exchange (BSE). From the date of announcement till the start of buyback on July 1, its stock rose 3.20 per cent from Rs 99.95 to Rs 103.15. CRISIL made a similar announcement on 18 October 2011. Between then and 26 December 2011, the day the buyback started, the stock rose 1.9 per cent to Rs 855.

However, Indiabulls Real Estate started moving southwards after the buyback announcement. The company announced a buyback on 15 December 2011, after which the stock tumbled 3 per cent to Rs 48.25 till 7 January 2012. The benchmark BSE Realty index fell 6 per cent from 1,447 to 1,398 during the period.

Stock Moves: The shares of a company entering into a buyback can move in either directions after the announcement
"The movement of a stock after the buyback announcement depends on valuations. The result can differ from company to company," says Gajendra Nagpal, founder and chief executive, Unicon Investment Solutions.

If you plan to invest in companies which are going to buy back their shares, market experts have a word of caution for you.

Despite the commencement of buyback, market experts have mixed views on RIL. For instance, Goldman Sachs upgraded its target price from Rs 960 to Rs 970 on 7 February 2012. However, according to a research report of Mansukh Securities and Finance issued on 4 February 2012, the stock can touch a level of Rs 660 in the next 12 months. On February 6, 2012, RIL was trading at Rs 832.75.

"You should not buy shares just because the company is working out a buyback plan. Investors must study the company they wish to invest in and take a decision based on its ability to generate profits. In some rare cases, buybacks are announced to trigger certain favourable movements (anticipation of an upward movement in stock price)," says Gilani of Mape Securities.

Goel of Karvy Private Wealth says, "It is important to look at the size of the buyback offer, the buyback price and the duration of the offer. This is because if the buyback size is too small compared with the overall market capitalisation of the company, the impact on the stock could be very small.

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