Source : (money control)
When a company senses that its shares are undervalued in the open market and has surplus cash, the firm decides to go for a share buyback offer.
A share buyback opportunity is always a dilemma-laden instance. Whenever a company rolls out a share buyback plan, the million-dollar question is whether to jump in or let it go?
Will it be a wise decision in terms of returns? Here are the details of the process and the options that an investor can exercise
What is a share buyback opportunity?
Fundamentally, a share buyback is done when a company decides to buy its own stocks (shares) from the open market at a premium (greater) price.
This is done for a number of reasons such as to enhance the value of remaining shares, to increase the overall holding value or to distribute less dividend in the forthcoming instances.
What is the need for a company to go for a buyback?
Traditionally, when a company senses that its shares are undervalued in the open market and has surplus cash for the buyback, the firm decides to go for a share buyback offer.
The process of share buyback also displays that company management is confident about the financial performance of the business in the near future.
What is the standard procedure of share buyback?
There are some essential steps involved before a company goes for a buyback. As the foremost step, the company has to announce its buyback date and the offer price well in advance
This is done to ensure that whoever is holding the company share on that date is eligible to participate. The company then rolls out a tender offer letter to all the shareholders.
This letter provides the finer details of shareholding and the number of shares one is selling to the company at the buyback offer price. The letter also holds the details of the tender period.
It is to be noted that a user can authorise a broker for buyback participation. In this case, the broker transfers the stock to the company from the clients Depository Participant (DP).
Once the paperwork is completed, the total value of the shares at the buyback price is paid by the concerned company directly to the client.
How does a client benefit from the buyback offer?
In most cases, the concerned company buys back its shares at an attractive premium (increased value) to attract more shareholders.
Let us assume that the current value of a company's stock is Rs 300 per share. In case of a buyback, the company may offer Rs 330-350 or even higher price. This premium will encourage shareholders to sell the shares back to the company.
However, it is advised two-three days ahead of the buyback record date, an investor can buy and hold the stocks in his DP. This makes a shareholder eligible for the buyback offer.
An investor generally has two options:
First, the investor can keep holding until the tender period. Once the company informs the investor about the quantity they are buying back, the investor can provide the company with the required stocks. The rest of the shares can be sold in the open market.
As part of the second strategy, once the record date for the share buyback elapses, the shareholder can sell the stocks. When the company issues a tender notification, the investor can buy it from the open market and sell it back to the company.
However, both strategies have their own advantages and disadvantages.
What are the major risks involved in a share buyback programme?
Generally, the percentage of the buyback is not decided in advance. If the company had gone for a 100 percent buyback, there would be n risk involved in the buyback.However, the percentage of buyback depends on open market participation. In general, the buyback varies from 10-50 percentage.For example, if a holder has 100 shares the company announces a 35 percent buyback, the company will rebuy only 35 shares at the decided premium.
This also means that you still have 65 shares of the company listed in the open market, exposed to the risks of the share market. Therefore, it is always advised to devise ones strategy in accordance with the risk appetite. (The author is Vice-Chairman, GCL Securities Limited)