Myth between dividend and Buy-back? who benefit from Buyback, Promoter, Shareholder or Government complete analysis.....

What is Buy back of shares?
Buy-back of shares in simple terms company buy its shares back from shareholders or open market.

Buy-Back is a corporate action in which a company buys back its shares from the existing shareholders usually at a price higher than market price. ... A buyback allows companies to invest in themselves. By reducing the number of shares outstanding on the market, buybacks increase the proportion of shares a company owns.

As per companies Act 2013 section 68 contains Power of company to Purchase its own securities…..
·        A company may purchase its own shares or other specified securities out of…..
 Its free reserves;
The securities premium account; or
 The proceeds of the issue of any shares or other specified securities

·        No company shall purchase its own shares unless…..
1     The buy-back is authorized by its articles;
2     A special resolution has been passed at a general meeting

Provided that nothing contained in this clause shall apply to a case where—
The buy-back is, ten % or less of the total paid-up equity capital and free reserves of the company; and
Such buy-back has been authorized by the Board by means of a resolution passed at its meeting;

3     The buy-back is twenty-five % or less of the aggregate of paid-up capital and free reserves of the company:

   The ratio of the aggregate of secured and unsecured debts owed by the company after buy-back is not more than twice the paid-up capital and its free reserves:

5     All the shares or other specified securities for buy-back are fully paid-up;

6     It should be made in accordance with SEBI rules and Exchange Regulations.

The notice of the meeting at which the special resolution is proposed to be passed under clause explanatory statement stating—
(a) a full and complete disclosure of all material facts;
(b) the necessity for the buy-back;
(c) the class of shares or securities intended to be purchased under the buy-back;
(d) the amount to be invested under the buy-back; and
(e) the time-limit for completion of buy-back.

Every buy-back shall be completed within a period of one year from the date of passing of the special resolution,

Prohibition for buy-back in certain circumstances.

 No company shall directly or indirectly purchase its own shares…..
·        Through any subsidiary company including its own subsidiary companies;
·        Through any investment company or group of investment companies; or
·        If a defaultis made by the companyin the repayment of deposits accepted either before or after the commencement of this Act, interest payment thereon, redemption of debentures or preference shares or payment of dividend to any shareholder, or repayment of any term loan or interest payable thereon to any financial institution or banking company

What could be the reason for Buy-back of shares…..

·         To improve earnings per share due to reduction of shares it increase the per share earnings. Example: company XYZ is having Equity capital of 1000000 shares @ 10 each; now company having surprise cash on books and doing 2 cr. Profit per year. Co came up with BUY-BACK offer with premium and bought back 10% i.e. 100000 shares. Earlier company was having earning per share of Rs. 20. Without posting more profit company indirectly through BUY-BACK reach at Rs. 22.22 due to reduction of 100000 shares.

·         To improve return on capital, return on net worth and to enhance the long-term shareholder value, in simple due to reduction in equity it increase return on remaining shares and also helpful for shareholder wealth creation.

·         To provide an additional exit route to shareholders when shares are undervalued or are thinly traded, Many company coming up with high premium where liquidity is issue, even it provide additional opportunity to shareholders. Example: Wipro came up with 325 Rs. BUY-BACK price while current price was near 280 Rs.

·         To enhance consolidation of stake in the company, many times promoter want to add stake in the company but due to poor liquidity or unwillingness to sell at current rate restrict promoter to reach their desired quota. Example. ELCID investment traded near 5 Rs. Came with BUY-BACK of 11500 Rs. To collect entire share of company.

·         To prevent unwelcome takeover bids- Many times in prevent era management of company doesn’t find and lucrative offer to expand business or risky takeovers. Example: Tata steel acquires Coras at aggressive price and company started facing many problems.

·         To return surplus cash to shareholders - Many company having huge cash on books of account which is shareholders fund. When company doesn’t find any opportunity for further investment it simple return cash to shareholders by paying premium through BUY-BACK.

·         To support share price during periods of sluggish market conditions - many promoter buys shares from open market to provide support share price during panic period. Especially small and mid cap even SME company usually such activity use to seen. TATA MOTOR bought in open market.

·         To service the equity more efficiently- by reducing equity number it is to be serviced good way.

Methods of BUY-BACK of shares:

A buyback allows companies to invest in them. By reducing the number of shares outstanding on the market, buybacks increase the proportion of shares a company owns. Buybacks can be carried out in two ways:

  • Shareholders accept a tender offer whereby they have the option to submit a portion or all of their shares within a certain time frame and at a premium to the current market price. This premium compensates investors for tendering their shares rather than holding on to them.
  • Companies buy back shares on the open market over an extended period of time.

Tax calculation of Buy-Back:

Sales consideration
Expenditure on shares plus (+)
Cost of acquisition/ indexed cost of acquisition

Sales consideration means the amount which is received or receivable by the shareholder due to buy back of those shares. 

Cost of acquisition shall be computed as per the provisions contained in section 48 of the Income-tax Act,

 The period of holding the shares is calculated from the day when they were purchased or acquired until the date on which they were bought back by the company. The gain arising from the buyback shall be chargeable to tax in the year in which the company purchases the shares.

It can be short term or long term capital gain depending on time frame of holding of particular shares.

Why dividend is not good for Promoter and High net worth Individual ?

One of the major reasons was the Union Budget 2016, which made dividend receipts above 10 lakh taxable at 10 per cent in the hands of investors. When a company declares a dividend, there is already a dividend distribution tax (DDT) on the payout. Besides, the dividend is paid out from the net profit, which in itself is arrived at after paying corporate taxes. So, Budget 2016 imposed additionally a tax on dividends (above 10 lakh) for high net worth investors and, therefore, made dividend payments unattractive. But when a buyback is conducted through the tender offer route on proportionate basis, the profit is treated as long-term capital gains. Even at a long-term capital gains tax of 10 per cent, this works out more economical than taxes on dividend payouts.

Most of the promoter of company hold more than 50% of stake in the company and declare say 1 Rs. Dividend and hold 50 lakh shares attract additional tax liability. While dividend is expense incur in eyes of company better to buy back few shares instead of issuing dividend.

Another aspect from promoter view is drawing big salary and pay 30% tax is also major concern this days.

Recent Buy-Back seen in last 3-4 Months in the below table…..

 Out of the Above company list most of the company near 20% or more trading near buyback Price. while below 5% buyback looks sole purpose of promoter participation in the buyback.

Process to follow for deciding Buy-back is worth applicable or not.....

Study company fundamental first
look at buyback size
study shareholding pattern of company
look at method of buyback whether promoter participation is there or not
derive Acceptance ratio
Look at open market condition is buyback is attractive or not 
many times good company having less liquidity value much times more than Buyback price Example. Elcid investment Buyback at 11500 value more than 200000
Most important point is promoter stake if stake is near 75% then promoter must participate else it is optional. If promoter is looking to harvest their money from the company it is alarming point.
Many company issue Buy-back price more than 110% of current market price, being an investor we be much happy but in reality Promoter participate in such company and withdraw huge money by paying just LTCG.

Four key situation for any investor to look for.....

If company is buying and promoter are participating in the buyback - be skeptical about the fundamental of stock

If company is buying and promoter not participating in the Buy back - stock must be Undervalued 

If promoter is issuing shares to himself - be skeptical about equity dilution always benefit the promoter

If promoter is Buying from open Market check the fundamental are OK or not and be bullish in such counter. Example: Mangal Credit Fin ltd promoter constantly buying shares from market one should check fundamental of the company and decide.

Happy Reading

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