The Share Buyback Conundrum

When investing in a stock, the desired returns can vary based on individual preferences, risk appetite, and liquidity needs. Some seek stock appreciation, aiming to sell at the peak of its value. Others prioritise consistent dividends as a reliable income source. Some find joy in observing unrealized gains on their favored stock-broking app.

Companies have a paramount duty to their shareholders: wealth maximisation. To that extent, share buybacks are a significant financial tool used by companies to deliver value to their shareholders.

This article explores the concept of share buybacks, why companies offer them, the factors that influence investor decisions when faced with a buyback proposal, and a comprehensive analysis of the recent buyback trends in India.

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A Growing Trend in Indian Markets

Share buyback programs have gained significant momentum in Indian markets over the years. Companies opt for share buybacks for several reasons:

1. Increase Earnings Per Share (EPS): By reducing the total number of shares outstanding, a company can increase its EPS, making the stock appear more attractive to investors.
2. Perceived Undervaluation: If a company believes its stock is undervalued, a buyback can be an effective way to signal confidence in its future performance and provide support to the stock price.
3. Balance Sheet Strength: A buyback can showcase the company's strong financial position, reinforcing investors' confidence in the firm.
4. Consolidation of Ownership: Companies may undertake buybacks to consolidate ownership and reduce the number of shareholders, which can simplify corporate decision-making.
5. Delisting from Public Markets: A buyback can be a step towards delisting the company's shares from public exchanges, making it a privately-held entity.
6. Boost Stock Price: Share buybacks can exert upward pressure on a company's stock price due to the reduced supply of shares in the market.
7. Return to Investors: By repurchasing shares, the company can distribute excess cash to shareholders, providing them with a return on their investment.

And for these reasons, the buyback activity in the Indian public markets has steadily increased year on year.

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Investor Perspective on Share Buybacks

Why would an investor consider accepting a buyback offer? Even when the stock is listed and easily tradable, several compelling reasons make buybacks an attractive proposition:

1. Premium Over Market Price: Share buybacks typically come with a premium over the current market price, providing investors with an immediate profit.
2. Tax Efficiency: Buybacks offer a more tax-efficient method of distributing wealth to shareholders compared to dividend declarations.
3. Assured Returns and Reduced Volatility: Investors receive a guaranteed return through buybacks, shielding them from market fluctuations.

However, the decision between holding onto shares or accepting a buyback offer is far from straightforward.

Despite the tax benefits and fixed premium offered by buybacks, market volatility presents a challenge. Investors, including hedge fund analysts and retail investors alike, often find it daunting to predict optimal entry and exit points in the stock market.

“The idea that a bell rings to signal when to get into or out of the stock market is simply not credible. After nearly fifty years in this business, I don’t know anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has.” - Jack Bogle

Rather than simplifying matters, exploring the buyback decision further adds complexity to the choice between holding or selling stocks.

To gain a clearer understanding, let's review the performance of certain stocks after the announcement of buyback proposals for the period January 2022 to June 2023, excluding taxation impact for simplicity's sake.

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TCS Buyback: A Tale of Ups and Downs

On January 12, 2022, Tata Consultancy Services (TCS) made headlines by announcing a buyback of shares worth ₹18,000 crore, marking it the largest buyback offer since the beginning of the calendar year 2022 till date. The company intended to buy back 4 crore shares at ₹4,500 per share, offering a generous 17% premium over the closing price on the announcement date.

At that time, TCS and the entire IT sector experienced a remarkable surge in stock prices. TCS shares had surged by approximately 22% in the trailing year, while the NIFTY IT index soared by around 43% during the same period. Given the positive outlook with upward revisions in future earnings forecasts for the IT segment since the pandemic's onset, it was not unreasonable for investors to hold onto their TCS shares, anticipating further growth.

However, the buyback proposal received an overwhelming response from investors. The subscription allocation of 4 crore shares was oversubscribed by an astounding 7.5 times. Investors eagerly accepted the buyback offer, rushing to seize the opportunity.

Had they chosen not to sell at that point, their experience would have taken a different turn. Following the initial surge triggered by the buyback announcement, the share price settled at ₹3,739 by the end of the financial year 2022-2023. This represented a deviation of 17% from the buyback offer price, with the stock almost reverting to its pre-announcement price level.

As time passed, the stock market encountered various challenges, including surging inflation, increased unemployment, and concerns about a global recession. By the end of the first half of the financial year 2023, TCS shares experienced a significant decline, reaching a low of approximately ₹3,000 per share. This marked a substantial downward revision of 33% from the buyback price.

Even today, TCS shares have not reclaimed the lofty heights set by the company's valuation. They currently sit at ₹3,415 per share, reflecting the ongoing market volatility and uncertainty.

The TCS buyback serves as a vivid reminder that market forces are often unpredictable, and investors must carefully assess their options when faced with buyback proposals.

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Bajaj Auto Buyback: Navigating Gains and Premiums in a Dynamic Market

On June 27, 2022, Bajaj Auto announced a share buyback proposal of ₹2,500 Crore, equivalent to 9.61% of the total paid-up capital of the company. The buyback was set to be executed through the open market mechanism, offering a buyback price of ₹4,500 per share, representing a substantial premium of around 24% over the closing price at the time of the announcement.

The stock initially showed promising momentum following the buyback announcement, reaching a price of ₹4,054 within a month. However, it faced resistance beyond that point and eventually settled at ₹3,616 by the end of the calendar year.

Despite this setback, 2023 proved favorable for the entire auto sector and broader markets, benefiting Bajaj Auto's stock price. As of May 8, 2023, the stock price surpassed the buyback price, crossing the ₹4,500 mark and is currently on the verge of reaching INR 5,000 at the time of writing this article.

Now, did the investors who opted for the buyback lose out? The answer is nuanced and depends on several factors.

If the investor opted for the buyback, they received a premium price on a stock that would’ve only been achieved if they stayed invested 13 months down the line. This would've also enabled them to free up cash flows for investments in alternative investment opportunities.

However, since Bajaj Auto’s stock market and financial performance have been on par with its competitors, the investor now may see a greater upside and would look to repurchase the stock at a higher earlier premium than what was realised at the time of acceptance of the buyback.

The Bajaj Auto buyback case exemplifies the complexities of investment decisions, where timing and market conditions play a crucial role. It also highlights the trade-offs investors must consider when participating in a buyback. As with any investment choice, there are both benefits and potential drawbacks, necessitating a careful analysis of the prevailing market dynamics and individual investment goals.

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In-Depth Analysis of Share Buyback Proposals: January 2022 to June 2023

The contrasting examples discussed earlier present a dilemma for investors, leaving them pondering the optimal strategy. To gain further clarity, we conducted a comprehensive examination of every buyback transaction during the 18-month period from January 2022 to June 2023, totalling an impressive ~₹66,470 crores in offer size across 80 publicly listed companies.

Our analysis focused on two critical aspects of these buybacks:

1. Achievement of Target Price: We evaluated whether companies reached their buyback target price.
2. Time to Reach Target Price: For those companies that attained their target, we scrutinised the duration it took to achieve the desired price.

Our findings revealed that 14% of companies successfully reached their target price within a short span of 3 months from the announcement of the buyback proposal. For instance, Balampur Chini Mills Ltd accomplished this feat remarkably within a mere 13 days—the fastest turnaround time observed among the analysed companies.

Interestingly, all companies in the "less than 3 months" bracket were smaller-sized buyback offers, with an average buyback size of ₹161 Crores, significantly lower than the average offer size of ₹831 Crores. On the other hand, 12 companies achieved their target within 6 months, but they had a comparatively larger average offer size of ₹237 Crores—a 47% deviation from the 3-month achievers.

For companies taking more than 6 months to reach their target, the average buyback size rose further to ₹262 Crores.

Our analysis suggests a potential correlation between the size of the buyback proposal and the time it takes to achieve the target offer price.

However, an examination of companies yet to reach their offer price raises intriguing questions. Surprisingly, despite the public equity markets touching all-time highs recently, a significant 51% of companies are still striving to attain the buyback price on offer. These companies' offers ranged from ₹5 crores to ₹18,000 crores, adding complexity to the understanding of market dynamics and investor decisions.

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Making the Right Investment Decision

Deciding whether to opt for a share buyback or hold onto a stock is a complex task that requires careful consideration of various factors:

1. Premium on offer
2. Historical performance of the stock
3. Market volatility and prevailing forecasts
4. Capital gains tax implications for shareholders
5. Need for liquidity
6. True understanding of the stock's fundamentals
7. Emotional biases
8. Investors' patience and discipline
9. Risk-return profile

Even after weighing these factors, there is no guarantee of making the perfect choice. As renowned investor Seth Klarman wisely advises, "Unprecedented events occur with some regularity, so be prepared."

In the ever-changing landscape of the financial markets, it is essential for investors to remain rational amidst irrationality. Making informed decisions, considering all available information, and staying adaptable will better position investors to navigate uncertainties and capitalize on opportunities.