What is buy back of shares, advantages of buy back of shares: All you should know about the share buyback

Share buyback is a win-win for all: Shareholders get a better price for their shares, promoters can increase their stake, and the company can improve its valuation parameters.

share buyback

In March 2022, TCS did a Rs 18,000 crore share buyback, the biggest this year (as of August 2022). On 12 January 2022, the company had announced that it would buy back the shares at Rs 4500 per share. On the announcement day, the TCS share price was around Rs 3860.

You must be wondering why TCS was buying back its shares at Rs 4500 per share when the market price was around Rs 3860. Indeed, what is share buyback? In this article, we shall discuss what is buyback of shares, why companies do it, various ways of doing it, and the taxation angle. We will also share a list of upcoming buybacks.

What is a share buyback?

Share buyback is a process through which a company buys back its own shares (from its shareholders) that it had issued earlier. A share buyback is one of the ways to reward shareholders. Other ways to reward shareholders include distributing dividends, offering bonus shares, etc.

Share buyback is usually done at a premium compared to the market price. The shares bought are extinguished, leading to a reduction in the number of outstanding shares.

Ways of doing a share buyback

There are two ways of doing a share buyback:

  1. Open market: In this method, the company buys the shares directly from the secondary market after announcing the timeline during which it will do the buyback. During the buyback, the company may buy the shares from the market at various price points. It announces the maximum price up to which it will buy the shares.
  2. Tender offer: A company can also ask its shareholders to tender their shares and announce a fixed price at which it will buy the shares. The shareholders may choose to tender all their shares, a portion of their shares, or no shares at all. To incentivise shareholders to participate and tender their shares, the company announces the buyback price at a decent premium to the market price.

If the company receives more shares than the maximum it wants to buy back, an acceptance ratio is worked out. The shares are accepted as per the acceptance ratio.

Also Read: 5 Most Expensive Shares In The World

Case study: TCS share buyback
Let us consider an example. On 12 January 2022, TCS announced that it would buy back four crore shares through a tender offer. The buyback details are given below:

TCS share buyback

(Source: https://www.chittorgarh.com/buyback/tcs-buyback/55/)

At the time of the buyback announcement, the market price of TCS shares was around Rs 3860. So, by announcing a buyback price of Rs 4500, TCS was offering a significant premium on the market price. TCS accepted 26% of the shares retail investors tendered in the buyback. For instance, if a retail investor tendered 50 shares, 13 shares got accepted.

Some reasons why TCS did the buyback are: returning excess cash to shareholders, increasing shareholder value in the long term, improving the return on equity, etc.

Also Read: 25 Stock Market Terms For Beginners

Why do companies perform a share buyback?

Here are some advantages of buyback of shares:

1) It tends to improve the company’s valuation parameters
When a company does a share buyback and extinguishes the shares, the number of outstanding shares reduces. With a lower number of shares, the company’s Earnings Per Share (EPS) and the Return on Equity (ROE) will improve. When the company’s EPS increases and the market gives the same price to earnings (P/E) multiple, the share price will go up.

2) It may signal that the company’s share price is undervalued
Whenever the overall market undergoes a big fall, cash-rich companies may announce a share buyback. Similarly, when a company’s share price falls significantly due to a particular short-term event, it may announce a share buyback. During such instances, the management signals to the shareholders and the overall market that the company share price is undervalued. It’s an indication that the management is confident about the company’s future prospects.

3) It allows promoters to increase their stake and fend off hostile takeovers
In some cases, where the promoter shareholding is low, the company may announce a share buyback to shore up the promoters’ stake. During such buybacks, the promoters do not participate. When other shareholders offer their shares in the buyback, the promoters’ holding automatically goes up. With a higher stake, promoters can fend off any hostile takeover attempts.

4) It is a way to return excess cash to shareholders
Share buybacks are one of the ways of rewarding shareholders (along with other ways, such as dividends). Debt-free companies with high cash reserves announce buybacks when the management feels the cash flow from operations can take care of funding requirements for future investments. Rather than carrying high cash on the books, the company returns the excess cash to shareholders through share buybacks.

Cash-rich IT companies such as Infosys, TCS, etc., announce regular share buybacks to return excess cash to shareholders.

Tax implications on buyback of shares

Section 115QA of the Income Tax Act deals with the tax on the buyback of shares. The section says: ‘Any amount of distributed income by the company on buyback of shares from a shareholder shall be charged to tax’. From 6 July 2019, any company doing a buyback has to pay income tax at the rate of 20% on the distributed income.

Distributed income is the consideration paid by the company on the buyback of shares minus the amount received by the company for the issue of such shares. For example, let us assume that a company has issued a share with a face value of Rs 10 at Rs 500. The buyback consideration is Rs 1200. In this case, the distributed income will be Rs 700 (buyback consideration Rs 1200 minus issue price Rs 500). The distributed income of Rs 700 will be subject to 20% tax.

Since the company is paying tax under Section 10(34A), the income accruing to the shareholder on account of the buyback of shares is exempt from taxation. In other words, there is no capital gains tax on shareholders for the net amount received by participating in the share buyback.

Also Read: What Are The Tax Implications If Firms Buy Back Their ESOPs?

Upcoming share buybacks
Here is a list of companies that have announced a share buyback:

Upcoming share buybacks

(Source: https://www.chittorgarh.com/report/latest-buyback-issues-in-india/80/?year=2023)

Note: The 'current market price' mentioned above is as of 23 August 2022. Further details regarding the buyback opening and closing dates are awaited from the companies.

Share buyback: A win-win for all stakeholders

A share buyback enables promoters to increase their stake in the company and fend off any hostile takeover attempts. It helps the company to improve its valuation parameters such as EPS, ROE, etc. It also allows shareholders get a higher price for their shares compared to the market price. So, share buyback is a win-win for all stakeholders involved.

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