Share buybacks: Positive, but tread with caution

While share buybacks send a positive signal to investors, there is a need to analyse each case on fundamentals and intent

Companies reward their shareholders in many ways, including by the way of paying dividends, issuing bonus shares or by buying back shares, among others. In the recent past, an increasing number of companies have announced plans to buy back their shares. This has led to the aggregate buyback figure rise to Rs 3,716 crore so far in this financial year — the second-highest in more than a decade .


While the emerging trend sounds positive, experts say there is a need to exercise caution, as many of these moves could be more due to the falling share prices and promoters’ intention to improve the sentiments about companies’ share prices.(Click here for table)
“Half of these buybacks are fake. Promoters have only one objective — to keep their share prices stable. But on Monday, the markets have become more mature and mere announcement of buyback at higher prices does not help,” says S P Tulsian of sptulsian.com. Thus, investors will need to analyse these offers individually and take a call to stay invested or exit such investments.
Using cash to work, but...
Like dividend payouts, share buybacks, too, benefit shareholders either directly or indirectly. Buybacks are considered good for the existing shareholders, as it not only helps improve overall sentiments about the stock but also returns ratios like return on equity (RoE), led by reduction in outstanding share capital. However, these moves typically prove beneficial only in case of companies that have surplus cash to deploy.
Take for instance the case of Piramal Healthcare. The company’s move is quite logical, given that it has ended up with large cash in its balance sheet after the sale of its domestic formulation business to Abbott and diagnostics business to Super Religare. Analysts estimate the company to have about Rs 7,000 crore in its books after payment of Rs 2,700 crore in tax. Given the company’s market capitalisation of Rs 9,736 crore, cash balance, prospects in existing businesses and future cash inflow of about $1 billion (from Abbott), it makes sense for investors to hold on.
Reliance Infrastructure, too, has announced a big share buyback offer. The company’s stock, which was on a declining trend since its 52-week high of Rs 1,225 in July 2010 to around Rs 700 in January 2011, fell to a low of Rs 492 last month due to the negative news flow about the group. At those levels, its share price was trading 32 per cent below its consolidated book value. To shore up investor confidence and send positive signal to the market about its growth prospects, the company announced the buyback offer. Though its share price recovered marginally, it is still 22 per cent lower than the maximum buyback price. Reliance Infrastructure has large cash and cash equivalents of Rs 14,000 crore in its consolidated books, including share of cash with Reliance Power. However, since most of it is likely to go towards funding its business growth, the stock valuation gap may take some time to reduce; till its various projects start generating revenues and profits. Patient investors with some appetite for risk may consider it.
On the other hand, companies like Hindustan Composites and Zee Entertainment did not announce a hefty premium over their current share price. However, the buyback news has helped their share prices. Zee Entertainment, whose share price fell from Rs 144 in December 2010 to Rs 108 in mid-January, has seen its prices trade closer to the buyback price of Rs 126.
However, the outcome may not be the same in all cases. Take, for instance, the case of Allied Digital. Its stock is trading at a 69 per cent discount vis-a-vis its buyback price, even as its PE works out to 3.4 times its trailing earnings. In its latest quarterly results, the company reported a 27 per cent decline in net profit to Rs 19.7 crore in addition to cutting its profit growth guidance from 30 per cent to 19 per cent for 2010-11. Also, the company was in news because of the income tax survey at some of its offices. This, the management clarified to be a routine search.
Experts, thus, say investors should look at key ratios like debt-equity, fund requirements, recent financials, etc, while assessing the real impact for the stock. “Irrespective of the buyback price (and offer) the investors should be careful about the buybacks till they are sure of promoters’ track record, fundamentals and financials of a company,” says Tulsian.