It's Here... Late, But Not Dead

FOR years, the pundits at the country's bourses have been clamouring for the buyback of shares. A year-and-a-half ago, the then president of the Bombay Stock Exchange (BSE), M.G. Damani, had written to P. Chidambaram, the then finance minister, that buyback of shares would, at one stroke, infuse the much-needed vitality to India's lacklustre bourses. Each year for the last five years, several companies have been getting the enabling resolution to buy back shares approved in the annual general meetings.

Finally, in late October this year, when the government passed the ordinance allowing buyback of shares, the markets became hopeful. "Buyback will definitely perk up shares of companies that the market has lost interest in," says Prateek Agarwal, chief of equity research at SBI Capital Markets. "Empirical evidence in other countries, primarily the US, suggests that share buyback programmes increase shareholder returns," says Jyoti Jaipuria, vice-president at DSP Merrill Lynch. Explains a banker, "The most important aspect of a share buyback programme is that it works like a safety net for investors, when the management expresses confidence that shares of a purchasing company are undervalued at a particular price."

Sure enough, rumours of impending buy-backs drove the market after the announcement. One case was Reliance Industries, whose shares surged in the last minutes of trade on November 12, gaining 8.8 per cent from a low of Rs 116.50 to close at Rs 126.80 on the BSE. Reliance officials declined to comment. Says Jaipuria, "As and when companies announce share buy-back programmes, share prices will go up."

But merchant bankers say the number of those that may go in for share buyback in the near future would be closer to 40. Even then, the aggregate value of these buy-backs is estimated to exceed a whopping Rs 4,000 crore.

The hitch: funds. "While companies have been talking about buyback for a long time, the number of companies that will actually avail of it is limited. Surplus funds are needed to effect buybacks, but since most companies are not doing well, the availability of cash is limited," says S.C. Bhatia, head of equities at ICICI Securities and Finance Company. To go in for share buybacks, companies need strong cash flows. Right now, there aren't too many companies that have that feature in India. However, some cash-rich multinational companies could go in for buybacks.

According to the draft Companies Bill, a firm can buy back its own shares or other specified securities out of its free reserves, securities premium account or the proceeds of a prior issue made specifically for the purpose of buyback. It will also be allowed to tap the public for funds to buy back its shares from the market. The firm's debt-equity ratio, post-buyback, should not exceed 2:1. This last stipulation could again knock a lot of companies out of the list of those wanting to buy back their own shares.

Companies may want to repurchase their own stock on the open market, usually common shares, for many reasons. Ideally, it should not be a short-term fix to raise the stock price but a rational use of cash, implying that its best investment alternative is to buy back its stock. These stocks are then extinguished. So if earnings stay constant, the reduced number of shares will result in higher earnings per share, which, all else being equal, should result in a higher stock price.

But there's a difference between an announcement and actually buying back stock. Last fortnight, market regulator Securities and Exchange Board of India (SEBI) announced what it called "liberal guidelines" for buybacks. Firms can now buy back their shares up to a maximum of 25 per cent of paid-up capital and free reserves. The SEBI regulations have built in enough safeguards for minority shareholders.

A company engaged in share buyback will have to make extensive disclosures in the form of an explanatory statement which has to be annexed to the notice for the general meeting and letter of offer to protect the interest of the investors. The promoter will also be required to declare upfront the pre-and post-buyback holding, leaving no room for manipulation. SEBI has put the onus of compliance with its regulations on the merchant bankers.

 "We have insisted on the association of a merchant banker in every buyback offer. The banker will have to provide us with a due diligence certificate," says D.R. Mehta, SEBI chairman. An offer for buyback will not remain open for more than 30 days except in the case of purchases made through stock exchanges. Companies that have defaulted in repayment of deposits, redemption of debentures or preference shares and repayment to financial institutions will not be allowed to buy back shares. According to the SEBI regulations, shares bought back have to be extinguished and destroyed within seven days.

Along with the buyback, SEBI has also modified its takeover code where buybacks would not affect SEBI's creeping limit of 5 per cent or threshold of 15 per cent for an open offer. To defend against hostile takeovers, a company can also announce a share buy-back after the date of public announcement of the takeover offer. Says P.N. Bhagwati, who chaired the SEBI-instituted committee on takeovers, "A share buyback offer made at the time when a takeover is in process will not be considered as a competitive bid. Both the buyback and takeover offers would be treated as mutually exclusive and hence governed by the respective regulations."

A buyback will be allowed only when a special resolution has been passed by a GBM. The company will have to make a full disclosure and say the buyback is necessary. It will have to disclose the class of securities intended to be acquired and the sum to be invested. Besides, it needs to mention when it will start buying back, which shall in no case exceed 15 months from the date of the passing of the resolution. Further, it must be clarified whether the buyback is proposed for reducing capital or for reissue after a period specified in the statement.

The buyback can be made from existing shareholders on a proportionate basis, from the open market or from odd lots, where investors hold a lower number of stocks than the minimum marketable. The shares can also be bought through negotiation or any other arrangement, subject to the condition that no votes are cast in favour of the special resolution by any person whose securities are proposed to be bought by such negotiation.

After the resolution has been passed, the company will have to file a declaration of solvency. The affidavit will have to declare that the board has made a full inquiry into the affairs of the company as a result of which it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year from the date of declaration adopted by it. After a buyback, the company cannot make any further issue of capital except by way of a bonus issue or in the discharge of existing obligations such as conversion of warrants, stock option schemes or conversion of preference shares into equity shares or debentures.

Internationally, buybacks are suddenly big. In the past month, several global giants have announced share buy-backs to boost their stocks. Knight Ridder, the second largest US newspaper publisher, has approved the repurchase of up to 3 million additional shares of its stock. Last month, IBM decided to expand its stock buyback plan by $3.5 billion, bringing the total authorisation to $27.5 billion since the programme began in January 1995. This month, German pharmaceutical company Schering declared that it planned to buy back DM 500 million ($297.3 million) worth of its own shares from November 12. Citicorp, the world's largest financial services company, also announced its plan to buy back $2 billion worth of its outstanding common stock. Swedish-US drugmaker Pharmacia & Upjohn is also implementing its largest-ever stock repurchase program for $1 billion.

In India, though, the buyback announcement has not brought the hoped-for level of cheer. The price rise and political uncertainty—the fear that the central government could fall after the state elections—have to a large extent neutralised the long-awaited ordinance. But in the next few months, share buybacks could be a major factor in lifting the economic gloom.