Page 103 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes where b = dividend payout ratio
g = (1 – b)(ROE)
where (1 – b) = plough back ratio.
The payout ratio can be calculated using dividend and earnings ratios:

b = (Dividend/Price)(Price/Earnings)

3.6 Share Buy-back

Buyback is reverse of issue of shares by a company where it offers to take back its shares owned
by the investors at a specified price; this offer can be binding or optional to the investors.

Case Study Buyback of Shares by MNCs in India

n the financial year 2001-2002, twenty MNCs made buyback offers. Some of the well-
known MNCs which offered to buy back their shares were Philips India Limited
I(Philips), Cadbury India Limited (Cadbury), Britannia Industries Limited (Britannia),
Carrier Aircon (Carrier) and Otis Elevators (Otis). All these companies made open offers
for the non-promoter shareholding in their Indian subsidiaries. To buy back shares,
Cadbury paid 9 billion, Philips 2 billion, and Carrier, Otis and Reckitt Benkiser all paid
over 1 billion.
According to analysts, the increased buyback activity by MNCs was due to three reasons.
They felt that the share prices of most MNCs were under priced and did not reflect the true
value of the company. Moreover, the buyback of shares allowed MNCs to convert their
Indian ventures into Wholly Owned Subsidiaries (WOS). It also allowed them to delist the
shares of these ventures from the stock markets and thus protect them from the volatility
of the stock markets (caused by scams and other market manipulations).
Analysts also felt that MNCs had used the buyback of shares as a method for distributing
surplus cash to their shareholders. Buyback also acted as a tool for creating wealth for the
shareholders. The buyback of shares improved a company’s return on equity (ROE), and
this improvement would ultimately be reflected in a higher price earning ratio.
Buyback by the company usually indicated that the management felt that the stock was
undervalued. It resulted in an increase in stock price, bringing it closer to the intrinsic
value. For example, when Philips announced its first buyback offer at a maximum price of
105 in October 2000, its shares were trading at around 60. The buyback announcement
resulted in an increase in the share price to 90 even before the buyback offer opened on
November 13, 2000. Hence, the buyback offer gave shareholders an exit option that paid
them a premium over the pre-buyback share price. However, in spite of the benefits of
buyback, a section of analysts and investors felt that it was being misused by MNCs.
Analysts felt that the buyback option may be misused by MNCs to increase their equity
stakes in their Indian ventures, escape public scrutiny and accountability and prevent
them from the Indian regulatory environment. Moreover, the option to convert their
Indian ventures into wholly owned subsidiaries and delist their shares from the stock

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