The Securities and Exchange Board of India (SEBI) has decided to do away with buybacks through open market operations or market purchases, on the basis of the recommendations made by the Keki Mistry Committee. These are probably the only legal means to support a share price when it is languishing.
Buybacks through tender offers were introduced to distribute a company’s the surplus funds. It also helped in reducing the number of shares outstanding. Distribution of surplus funds could also have been done by paying dividends, which would have been more equitable.
But the number of shares outstanding wouldn’t have been reduced and the tax treatment in the hands of the recipient would have been more adverse.
Two popular routes
In share buyback through the market, the maximum market price to be paid is set by the management. As a result the management looks at an opportunity when the market price is below the estimated intrinsic value and attempt to buy the shares at the lowest possible price. These shares will then be extinguished. Further, earnings spread over a fewer number of shares, will lead to a higher EPS and hence a higher share valuation. The benefit will be to the continuing shareholder and the exiting or selling shareholder loses out.
Naturally and intuitively speaking, any taxes on gains made by the seller, will be normally borne by the seller. But currently rules and laws regarding taxation have been modified over time, with the taxes being paid by the buyer. This is a debatable aspect of buybacks.
The other method of buyback, is the tender offer method. Here a company with surplus funds, makes an offer to all shareholders at a fixed price usually above market on a basis, proportionate to their holdings. Though small shareholders get a small additional allocation, but due to a lack of involvement they don’t fully participate. The professional shareholders and promoters participate to the hilt, as they are fully aware of the easy money on offer due to above-market purchase price. The bonus is that the tax on gains made by them is paid by the company, which is a unique feature of India.
Buyback via markets
The apparent shortcomings of the market purchase method according to the Keki Mistry report, are that in closely held companies, the prices and timing of the purchases are manipulated by the promoter to their benefit. The promoter offers or sells most or a disproportionate number of the shares being bought. This can be easily monitored by SEBI and manipulative and abusive practices can be dealt with.
The second shortcoming, is that apparently, due to the six month offer window, this is a way to maintain the share price higher than what it should be. That is by quoting a high buyback price, the market price will adjust upwards.
This is a poor or specious argument for abolition of the open market buyback. Rules can easily be framed to overcome this issue.
To appreciate the theoretical arguments given above, the example of GE Shipping is illustrative.
On December 24, 2021, when the share price was languishing at ₹295, it had an EPS of ₹55 and a PE of under 6. It had cash equivalent of ₹4,000 crore. It announced a buyback starting on January 7, 2022, to end on July 6, 2022 (six months) with an allocation of ₹225 crore and a ceiling price of ₹333. It purchased about 42 lakh shares, reflecting 59 per cent of the target, utilising ₹133 crore at an average price of ₹312.21, before the market price crossed the ceiling price.
Currently, the share price is ₹646. A big gain for the continuing shareholders. Most of the increase is probably due to the re-rating of the stock, but some of the increase is also due to the buyback.
Looking at the tender offer method, we can take the case of Garware Technical Fibres Ltd, which announced a tender offer on October 22, 2022, at a price of ₹3,750 per share, for 2,40,000 shares, amounting to ₹90 crore, when the price was in the range of ₹3,300-3,400. The shares bought from the small holders were 36,000 (17 per cent); promoters 109,196 (53.53 per cent), FPI/MF 37,298 (18.28 per cent), roughly proportional to their holdings. This is fair enough.
But today the price is ₹3,078. Those who participated in the buyback would have made a hefty tax free gain, but would have taken a hit on the residual shareholding. The continuing shareholders have seriously suffered. This is not a healthy outcome.
The takeaway here is: In open market purchases the share price tends to go up, post buyback; in tender offers, the share price tends to go down post buyback.
In conclusion, taxation on buyback needs to be rationalised at the earliest with the tax incidence being borne by the recipient.
Please do not consign the concept of buyback through open market purchases to the pyre. It needs to live forever.
The writer is a chartered accountant
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