As Warren Buffet rightly said “The stock market is a device for transferring money from the impatient to the patient” and to attribute to that, stock buyback is one of the examples of the same as the impatient being the company and the patient being the shareholders.
Before we land ourselves on the debate whether a buyback is a boon/ deception in the current scenario lets first understand the idea of it, stock buyback means repurchase/ re-acquisition by a company of its own share. A buyback is a more flexible way to pay back the shareholders as the market value per share and acquire the portion of its ownership that was previously distributed between the private or public investors.
They are hence governed under the Companies Act, 2013 under section 68 and regulated by section 24(i)(f) under SEBI (Buy-back of Securities) Regulations, 2018.
There are various reasons for buy back of the shares such as Utilization of excess cash v/s poor investment options, nowadays, the companies prefer to invest their excess flow of cash in buy backing the shares rather than investing in something which according to their needs isn’t up to the mark, the advantages of using their excess fund in buy backing is a great opportunity for them in order to return the cash to their stakeholders and get the distributed ownership back in their hands which is a great signal for a growing company.
Secondly, Improvised Valuations- It is believed that when a company buybacks the share then the valuation of the company is improved as it results in a reduction of shares outstanding and the capital base. As the stock trade is based on supply and demand, the reduction of shares outstanding would, however, boost the price, therefore, a company can bring about an increase in its stock value by creating a supply shock.
Thirdly, Undervalued stocks- Majority of the time when a share is a buyback by the companies, that’s because the management of the companies believes that the shares are undervalued.
Fourthly it acts as a Protection for promoters and lastly, it also entails certain Tax benefits.
Compared to the other developed nations, buyback is relatively new and an emerging concept in the Indian market. It indeed gave a new concept to the Indian companies to restructure their capital requirements, allowing them to use capital more effectively and efficiently.
To help this current scenario, on the request and representations made by various industry bodies, in a recent circular by the Stock Exchange board of India has reduced the time gap on capital raising after buyback to six months from one year to help the companies to raise funds more efficiently.
And after this relaxation, a lot of companies are considering or in fact announced buybacks. Companies like Sun Pharma, Thomas, Supreme Petrochem, Emami and SP Apparels, Granules India, Indiabulls Housing Finance, NIIT Tech, Kalpataru Power Transmission, Justdial etc.
Yes, in the recent times it is to be believed one of the most flexible ways, by increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earning per share (EPS) targets. All that said, buybacks can be done for perfectly legitimate and constructive reasons. But By this increasing practice of buybacks, the company’s actual goal which is to grow and make profits is really hitting a wall. Some economists and investors argue that using excess cash to buy up their stock in the open market is the opposite of what companies should be doing, which is reinvesting to facilitate growth (as well as job creation and capacity).
But the main question sustains is a buyback, the only resort to stabilise the stock price in the market as many critics believe that buybacks are self-centred by the management of the companies.
On the contrary, Kotak Mahindra bank who by not opting for buybacks announced a mega share sale to raise 7,500 crores to over combat liquidity risk during the COVID.
Also, Facebook buys 9.99% stake in Reliance Jio, an all-cash deal that will help the oil-to retail conglomerate reduce debt and strengthen the social media company’s presence in its largest market especially for its WhatsApp unit.
Although the last move by SEBI will definitely boom the buyback practice and buy back shall remain the preferred choice at this time for such economic low.
And the question stands, Are companies deliberately failing in operating other factors than just buybacks?
It would be very hard to anticipate the future of the economic direction, Nevertheless, passion for prosperity over profits is one of the driving principles even in layman terminology. As rightly said by George saros “ Stock market bubbles don’t grow out of thin air, They have a solid basis in reality, but reality as distorted by a misconception”.
Lastly, With Chinese Researchers acknowledging Indian inbuilt immunity to Covid19 and Indian Government’s proactive and prompt change in FDI norms to insulate from opportunistic predators, it will not be an understatement to recommend the Corporate Entities to refrain from hastened buybacks. A little dip of benevolence to be learnt from Mr Uday Kotak to lower the income to Re. 1 for a while is sure to be not remembered as a sacrifice after all.
This Article is written by Kapil Joshi and Vibhuti Seth. Kapil Joshi is a Counsel practising in the Supreme Court of India, and founding partner at Kashi Nath Partners. Vibhuti Seth is an Associate at Kashi Nath Partners, handling Commercial advisory, litigation and consultation.
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