[Apurva Lahoti is pursuing the Master of Laws (LLM) programme from WBNUJS Kolkata.]
The expression ‘buyback of shares’ simply refers to an activity wherein the corporate entity takes back its issued shares from its shareholders pursuant to section 68 of the Companies Act, 2013 (Act). By virtue of the said provision, not only public but also private companies can purchase their own issued securities from the following three sources:
free reserves;
securities premium account; and
proceeds of the issue of any securities.[1]
This buyback shall be lawful provided the company is permitted to do so by its articles and fulfills all the requirements as mandated by section 68 read with the Companies (Share Capital and Debentures) Rules, 2014 and the amended Securities and Exchange Board of India (Buy-back of Securities) Regulations, 2018.
The price at which these shares are bought back is usually slightly higher than the price prevailing in the market. A significant advantage which a buyback proposes to serve is that it assists in upgrading the market price of the share. There are several other positives which a buy-back offers; for instance, it targets at revamping the earnings of an individual share and returning the superfluity of unused capital with the enterprise to the shareholders, among other things.
The less the company diversifies and makes efficient investments, the more it is flooded with a pile of unutilized cash in its account. Given such circumstances, in order to ensure that the faith of the shareholders in the company is not diminished, the company resorts to certain options, one of which is buy-back. A buy-back has its pros and cons, and could work in favour or against the company, depending on various factors. On the one hand, a buy-back is indicative of the company’s unwillingness to expand its horizons, and on the other, a buy-back can also be perceived as the company’s strategy to strengthen its market position, which is possible only when there exists a large stack of free cash reserves.
The software giant Infosys enjoyed stagnant good days during the reign of its founder and then Chairman Narayan Murthy. No doubt the journey of Infosys has been incredible and it went on to become a multi-bagger company, but the reason behind using the words "stagnant good days" together is because though their software business was expanding through different cities in the country, it somehow refrained from making any huge acquisitions. Billions of dollars lying with the company were not being put to any substantial use, and this money found its way into bank accounts and mutual funds, which naturally provided returns at an extremely low pace. The only major accession that the company participated in was ‘Lodestone’ based in Switzerland, priced at around $345 million, in the year 2012.
However, the above mentioned scenario was an attempt to enter the phase of transition with the entry of the new CEO of Infosys, Vishal Sikka. He begged to differ from Narayan Murthy’s ideology. However, things turned sour between the company and the CEO, following which he resigned, as a result of which the share price witnessed a noticeable downfall. The share price, which was around Rs. 1,200 during that period, dipped down in the series of Rs. 800. Immediately after this resignation, a buyback plan of nearly Rs. 13,000 crores, meaning buying back 11.3 crore shares, was approved by the Board of Directors. This, when calculated in percentage, amounted to 4.9% of the paid-up equity capital of Infosys. The buyback offer price exceeded the existing market value by around Rs. 225 per share. The offer price proposed was Rs. 1,150, and this was aimed to provide a breathing space to the shareholders, and to make up for the dip in share price. This strategy turned out to be successful, for within a couple of days, the share price stirred up to its earlier position. Therefore, having such massive unutilized cash flow was a saving grace for Infosys, and it was able to make up for this unexpected collapse in the share price in no time. In its 36 year history, the corporate giant, for the first time, concluded a buyback programme in December 2017.
Even after the said buyback, it had thousands of crores of free cash. A single buy-back mission was not considered as sufficient to boost the shareholder value, owing to a considerably low growth rate in 2018, and Infosys was compelled to give a thought to another buy-back plan by the investors. As an alternative remedy, it could opt for the idea of giving out a major portion of its free cash to investors as dividends. However, this could not be equated with the consequences of buy-back.
The soundness of buying back shares is contingent upon the company’s annual revenue generation. A buy back is desirable when the growth is static or low. The net profit of Infosys stood at Rs. 3,610 crores after the December 2018 quarter results. This figure, when looked at individually, is not bad, but it did not live up to the expectations either. It saw a decline of around 12% when compared to its September quarter net profits and an approximate 30% decline when compared to the previous year December quarter profits.
Recently, a second buyback proposal amounting to Rs. 8,260 crores and a special dividend of Rs. 4 per share was granted a green signal by the Board in order to ameliorate the present scenario. In a market where even the buzz of a possible buyback made the price of the shares of Infosys rise by 2%, the possible effect of the announcement of this decision can only be predicted. It may appear to the shareholders as well as the general public that the company has taken one of the best decisions which is going to land the investors in a profitable situation. Well, the probability of such a situation to arise cannot be denied, but a twist in the tale here is the mode of the buy-back.The recent buy-back has been declared by the company to take place through an open market route, whereas the initial buy-back had taken place through a tender offer route.
Understanding the difference between the two is relevant to make any thoughtful prediction. Firstly, the difference pertains to fixation of the buy-back price, which in a tender offer is fixed at a particular price. However, in an open market, only a maximum slab is provided, which in the instant case is Rs. 800, and the company is free to purchase in different quantities at any price below this maximum slab, as it deems fit. Due to this, the open market method puts the shareholders in a dilemma as to when they should give out the shares for purchase, as it becomes difficult for them to decide the time of best value, and this dilemma is ruled out in the latter method. Secondly, the duration to comply with the tender offer route is one month, which, in the case of the open market route, is extended to one year, and this makes the process continue all through the year. Thirdly, while in the tender offer route, the investors can beforehand calculate the profits they would be making, there is no chance of doing so in the open market route.
There are sundry differences between the two buy-backs, and the long-term effects of the latter are yet to be fully realised as nothing can be said with certainty about the stock market. Even though there is a slight upsurge in the share price of Infosys after the declaration of the second buy-back, this state can only be stated to be temporary, and cannot be said to be conclusive of any result. Any move made by one of the most influential MNCs in the country creates a rippling effect on the financial market, and hence, it will be interesting to witness how the second buy-back move would play out in reality.