Buyback of Shares - A complete Guide

The main focus of this article is to make short-term investors aware of the buyback process in general and how to make a profit out of it.

The term "Buyback" is gaining popularity after announcements of buyback by IT majors like Cognizant, TCS, Wipro, Infosys. Whether you are a long term investor in the company or planning to buy shares for the short term to take part in a buyback, you can make a decent return in both cases.

Anyone who is holding the stock for the long term and has a net holding of Rs 2 lakh and less, buyback makes a lot of sense. If you are someone who is planning to buy shares now, then buyback leaves you with a good return in around 3 months (times it takes to complete the buyback through tender offer). In Buyback with the tender offer, the Registrar decides on how much % of the shares will be bought back depending on the volume of the buyback. This is called the acceptance ratio. If 100% of the shares are not bought back, then also investors can get a good return but a bit lower. Also, one has to pay short-term taxes if buying shares now and selling before a year.

Meaning of Buy-back of Shares

When a company repurchase its outstanding shares from the open market by either of the two ways- tender offer or through open market, the process is called Stock Buyback or Shares Buyback. It is also known as Shares Repurchase. The company usually buy its own outstanding stocks or outstanding equity from the existing shareholders in exchange for the cash. Such transactions are legal and generally monitored by SEBI. Buyback has 15% reserved for retail investor with less than 2 lakh worth of holdings and 85% for non-retail investors which include promoters, MF, FII, DII etc.

Buybacks can be carried out in two ways:

Tender Offer Buyback

In this process, shareholders are presented with a tender offer where they have the option to submit or tender a portion or all of their shares within a given 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. In the tender offer, these three things are pre-specified:

• Buyback Price
• Duration of the offer
• Number of shares sought by company

If the number of shares tendered exceeds the number sought, then the company purchases less than all shares tendered at the purchase price on a pro rata basis to all who tendered at the purchase price. This is called as proportionate buyback. If the number of shares tendered is below the number sought, the company may choose to extend the offer’s expiration date.

Open Market Buyback

In this process, the company buys shares up to a certain number not necessarily the whole announced quantity through the open market over an extended period of time and may even have an outlined share repurchase program that buys back shares at certain times or at regular intervals. The maximum price is fixed and the buyback can be done upto or below that particular price, not beyond.

Reasons why the company offer Shares Buyback

Following are the reasons why the company repurchase its own shares:

• It reduces the number of shares held by the public, thus the earnings per share increases even if profit of the company remains the same.
• It supports the share price during periods of sluggish market conditions.
• Buyback helps to take advantage of undervaluation. The company repurchase the currently undervalued shares, wait for the market to correct the undervaluation whereby prices increase in the intrinsic value of the equity, and re-issue them at a profit.
• Share Buyback helps reducing the cost of capital. Buying back some or all of the outstanding shares can be a simple way to pay off investors and reduce the overall cost of capital instead of paying the dividends which is a cost of equity.
• Companies also more readily repurchase shares at a profit when the stock is liquidly traded and the companies activity is less likely to move the share
• Share repurchases also allow companies to distribute their earnings to investors without inflicting them with taxation.
• Share repurchases avoid the accumulation of excessive amounts of cash in the corporation.

Benefits a retail investor gets from Buyback

Buyback would lead short term or long term gain depending upon what type of investor you are.

Long term investor

Long term investor can sell their holding via tender offer and in cash the profit from this opportunity when the company is buying shares at higher prices. If you have shares lying in your account for more than a year, then the long-term capital gains generated from buyback will be tax-free same as selling long-term holdings in the open market.

Short term investor

Short-term investors can make quick money by making a fresh position right before a scheduled buyback. The short-term investor can start accumulating stocks when buyback is announced/approve of the company. Retail Investors are allowed to tender a max of Rs 2 lakhs in the buyback process. Usually, the buyback price of the stock is 10 to 15% higher than the market price. Still, you need to carefully consider the offer price, before tendering your shares under buybacks, because you stand to gain only if the buyback offer price is significantly higher than the prevailing market price and the quantum of the buyback amount is substantial. Remember, you need to pay 15% tax on the short term capital gain.

Example: TCS recently announced buyback when the stock price of TCS was 2350 Rs per share and the buyback offer price was 2850 Rs, in this example, if you are holding TCS shares or able to accumulate TCS share worth of INR 2 Lacs in your account on and before offer date, depend on buyback quantity approved by the registrar you can get Rs 500 per share. Sometimes, due to over-subscription, there is a chance that only 50% or 30% of your shares would be buyback and you would be holding the rest. There is a little chance of this happening but we want you to know the risk before taking any decision of whether you should go ahead with the buyback.

There is a flip side of buyback when the market price of the stock is higher than the offer price, in such case selling the stock at market rather than tendering it for the buyback will be beneficial for investors.

Portion of shares that can be bought back from Retail Investors

15 % of the buyback shares are bought back from retail investors and 85% is reserved for the non-retail investor which includes promoters, MF, FII, DII, etc. In most of the recent buybacks, the retail portion is under-subscribed, leading to a 100% acceptance ratio.

When a company announces the number of shares they want to buy back, Of which 15% is only bought back from small investors with less than 2 lakh worth of holding. But like a lot of people who are aware of the buyback offer, many retail investors start accumulating shares of the company before the buyback date is announced. So it is a possibility that the number of shares held by the small investor could be more than 15%. In such a case, due to the over-subscription of shares, proportionate buyback happens. So there are chances that only 50% or 30% would be brought back and you would end up holding the rest.