Page 106 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 3: Introduction to Security Analysis

2. Recently the prices of RIL and REL have not fallen, as expected, despite Notes
the spat between the promoters. This is mainly attributed to the buyback
offer made at higher prices.
Exit Option: If a company wants to exit a particular country or wants to close the company.
Escape monitoring of accounts and legal controls: If a company wants to avoid the regulations
of the market regulator by delisting. They avoid any public scrutiny of its books of accounts.
Show rosier financials: Companies try to use buyback method to show better financial ratios.

Example: When a company uses its cash to buy stock, it reduces outstanding shares and
also the assets on the balance sheet (because cash is an asset).
Thus, Return On Assets (ROA) actually increases with reduction in assets, and return on equity
(ROE) increases as there is less outstanding equity. If the company earnings are identical before
and after the buyback Earnings Per Share (EPS) and the P/E ratio would look better even though
earnings did not improve. Since investors carefully scrutinize only EPS and P/E figures, an
improvement could jump-start the stock. For this strategy to work in the long term, the stock
should truly be undervalued.
Increase promoter’s stake: Some companies buyback stock to contain the dilution in promoter
holding, EPS and reduction in prices arising out of the exercise of ESOPs issued to employees.
Any such exercising leads to increase in outstanding shares and to drop in prices. This also gives
scope to takeover bids as the share of promoters dilutes.

Example: Technology companies which have issued ESOPs during dot-com boom in
2000-01 have to buyback after exercise of the same.
However the logic of buying back stock to protect from hostile takeovers seem not logical. It
may be noted that one of the risks of public listing is welcoming hostile takeovers. This is one
method of market disciplining the management. Though this type of buyback is touted as
protecting over-all interests of the shareholders, it is true only when management is considered
as efficient and working in the interests of the shareholders.
1. Generally the intention is mix of any of the above

2. Sometimes Governments nationalize the companies by taking over it and then compensates
the shareholders by buying back their shares at a predetermined price.

Example: Reserve Bank of India in 1949 by buying back the shares.

Task Find out the methods in which buyback can happen and discuss them with
examples.

3.6.2 Restrictions on Buyback by Indian Companies

Some of the features in government regulation for buyback of shares are:

1. A special resolution has to be passed in general meeting of the shareholders
2. Buyback should not exceed 25% of the total paid-up capital and free reserves
3. A declaration of solvency has to be filed with SEBI and Registrar of Companies

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