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Nachiket Kelkar
Nachiket Kelkar

SHARE BUYBACK

Share buybacks between Jan-Aug, cross total buybacks in 2016

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Bengaluru based real estate firm Sobha Limited's Rs 62 crore share buyback offer opens for subscription on Sept 19. The company is looking to buy 14.58 lakh equity shares at Rs 425 per share, amounting to 1.5 per cent of the company's total paid-up equity share capital.

Sobha's share buyback is small compared to software services exporter, Infosys' Rs 13,000 crore buyback announced earlier this year. But it shows companies, big and small, have caught a fancy for buying back shares in a big way to reward their investors.

Between January-August 2017, 38 companies announced buyback offers worth Rs 31,040 crore, eclipsing the 37 offers worth Rs 28,234 crore in the whole of 2016 according to data from Prime Database, which tracks capital market activity.

Share buybacks are a way companies can distribute cash to their shareholders, just like a dividend. Buybacks also give an option for the shareholders to sell their shares in part or full through this route, where the price offered by the company may be slightly higher than the prevailing market price. But, why are so many companies buying back shares?

There are multiple reasons behind a company's decision to buyback shares. It may have huge amount of cash, and may want to return some of it to investors. The promoters may believe that the stock is undervalued at a particular point of time and therefore may offer to buyback a portion of shares at a price higher than market price, or the company may be finding limited investment or expansion opportunities and so, may chose to utilise its cash to payback shareholders instead.

In any case, a share buyback would reduce the total number of outstanding shares in the market, thus improving the company's earnings per share (EPS). This will benefit shareholders who stay invested in the company.

“Announcement of a buyback could send various signals to investors ranging from an optimistic view (if undervaluation of stock is cited as the reason for the buyback followed by company insiders not participating in the buyback or actually shoring up their holdings) to a neutral to pessimistic view (if surplus cash generation and inability to deploy cash in business is cited as the reason for the buyback followed by company insiders participating in the buyback),” noted Vinod Karki, vice president at ICICI Securities.

But another major reason behind the surge in buybacks, according to market experts, is related to the change in taxation norms for dividends in 2016 Union budget.

Income from dividends is typically taxed by way of a dividend distribution tax (DDT). In the 2016 Union budget, an additional tax at 10 per cent of the gross amount of dividend was levied on those receiving dividends more than Rs 10 lakh per annum.

The dividends in excess of Rs 10 lakh per year would thus attract an effective tax of more than 32 per cent, which includes DDT of 20.90 per cent payable by the company distributing dividend and additional tax of 10 per cent (plus surcharge and cess) on shareholders levied in the budget.

In comparison, a company doesn't pay any tax on buyback of shares. Plus, long term capital gains on transfer of equity shares, if held for more than one year, and securities transactions tax are also exempted from tax. Short term capital gains are subject to a tax of about 15 per cent.

Thus, one can see that purely on the basis of tax, share buybacks are much more favourable than dividends.

In 2014-15, there were only 10 buybacks worth Rs 605 crore. In 2015-16, there were 16 buybacks worth Rs 1,834 crore. Last financial year (2016-17) it rose sharply to 49 buybacks worth Rs 34,468 crore. Between April-August this fiscal year, there have been 20 issues amounting to buybacks worth Rs 24,215 crore, according to Prime Database.

Securities and Exchange Board of India (SEBI) recently expressed concern over the sharp rise in buybacks, which had surpassed the total fresh capital market fund raising in the last two years.

“The amount, which went back to investors was 1.5 times that of raised (equity capital). More money is being returned to investors against money raised,” said Ajay Tyagi, chairman of SEBI.

According to Tyagi, the rise in share buybacks was a reflection of constraints in investment opportunities. He was hopeful that the situation would change with more initial public offerings being planned in the coming months.

The top software exporters, TCS, Infosys and Wipro, all announced huge share buybacks this year amid uncertainty in the overall IT environment particularly in the US, their biggest market.

The rise in share buybacks has also caught the eye of the taxman. The Central Board of Direct Taxes (CBDT) is reportedly examining if buybacks can be excluded from the exemption they currently get on long term capital gains tax.

If the tax department does have its way then share buybacks could also attract a long term capital gains tax and that would force the companies to rethink on their strategies once again.

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Topics : #stocks

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