What is Share Buyback?
Buyback of shares which is also known as share repurchase or stock buyback, denotes to the practice of a company buying its own shares from the market or from its existing shareholders. In other words, it is the process by which a company uses its own funds to purchase its outstanding shares, thereby reducing the total number of shares in circulation.
Reasons of Shares Buyback:
Companies may initiate share buybacks for a variety of reasons, out of them followings are few:
- Capital management: By repurchasing shares, a company can return excess capital to its shareholders, which may be viewed as a more tax-efficient way of returning value to shareholders compared to dividends.
- Boosting shareholder value: Share buybacks can potentially increase the value of existing shares by reducing the total number of shares outstanding, which can result in higher earnings per share (EPS) and, in turn, potentially boost the company’s stock price.
- Defence against hostile takeovers: Share buybacks can be used as a defensive measure to make it more difficult for other companies or investors to acquire a controlling stake in the company, as it reduces the number of shares available for purchase.
- Employee stock options: Share buybacks can be used to offset the dilutive effect of employee stock options or other equity-based compensation plans by retiring the repurchased shares, which can help to maintain the ownership percentage of existing shareholders.
- Excess cash: Companies with large amounts of cash on their balance sheets may use share buybacks as a means to deploy excess cash in a way that can potentially benefit shareholders.
- Tax Efficiency: Share buybacks can be a tax-efficient way for a company to return capital to shareholders compared to other methods such as dividends. In some jurisdictions, capital gains tax on share buybacks may be lower than dividend tax rates, making it an attractive option for returning capital to shareholders.
What are the methods of share buybacks?
There are several methods of share buybacks that companies generally use to repurchase their shares, like:
- Open market purchases: In this method, a company buys back its own shares from the open market through a stock exchange. The company places buy orders for its shares just like any other investor, and the shares are bought at the prevailing market price. Open market purchases are the most common and flexible method of share buybacks, as the company can repurchase shares over a period of time, based on market conditions and its available cash reserves.
- Tender offers: In a tender offer, a company makes a public announcement inviting its shareholders to tender their shares at a specified price within a certain time frame. Shareholders can choose to accept or reject the offer, and the company repurchases the shares of those shareholders who tender their shares. Tender offers are typically used for large-scale share buybacks, as they allow companies to repurchase a significant portion of their outstanding shares in a relatively short period of time.
- Dutch auction: A Dutch auction is a type of tender offer where the company sets a range of prices at which it is willing to repurchase its shares. Shareholders then submit bids indicating the number of shares they are willing to sell and the price they are willing to accept. The company then determines the lowest price that allows it to repurchase the desired number of shares, and all shareholders who submitted bids at or below that price are repurchased at the determined price. The Dutch auction method provides an efficient way for companies to repurchase shares at the best possible price, as it allows shareholders to set their own selling price.
- Accelerated share repurchase (ASR): In an accelerated share repurchase, a company enters into an agreement with an investment bank to repurchase a specified number of shares at an agreed-upon price. The investment bank then borrows shares from its own inventory, or buys shares in the open market, and delivers them to the company. The company makes an upfront payment to the investment bank, and the actual number of shares repurchased is determined based on the volume-weighted average price of the company’s shares during the term of the agreement. ASRs are used when a company wants to repurchase a large number of shares in a relatively short period of time.
- Private negotiations: In some cases, a company may negotiate directly with one or more of its large shareholders to repurchase their shares in a private transaction. This method is less common and typically used when a company wants to repurchase shares from specific shareholders, such as insiders or institutional investors.
Impact of shares buyback are:
- Shareholders: Share buybacks can impact shareholders in several ways. First, buybacks can increase the value of remaining shares by reducing the total number of outstanding shares, thereby increasing earnings per share (EPS). This can potentially lead to an increase in stock price and shareholder wealth. Second, buybacks can provide an exit strategy for shareholders who want to sell their shares, as the company purchases shares directly from them. However, if the company overpays for the shares, it may result in a loss for shareholders. Additionally, buybacks can also reduce the amount of cash available for other purposes, such as dividends or reinvestment in the business, which could impact long-term shareholder value.
- Company: Share buybacks can impact a company’s financials in several ways. First, buybacks can reduce the company’s cash reserves or increase its debt levels, as funds are used to repurchase shares. This can impact the company’s ability to invest in growth opportunities or meet its debt obligations. Second, buybacks can impact the company’s financial ratios, such as return on equity (ROE) and earnings per share (EPS), which are important metrics used by investors and analysts to assess a company’s financial health and performance. Additionally, buybacks can also signal management’s view on the company’s valuation and future prospects.
- Employees: Share buybacks can impact employees in various ways. If the company uses its cash reserves or borrows money to fund buybacks, it may result in reduced funds available for employee compensation, benefits, or other investments in human capital. On the other hand, if the buybacks result in an increase in stock price, it could potentially benefit employees who hold company stock or stock options as part of their compensation. However, this may depend on the terms of the stock-based compensation plan and the timing of the buybacks.
- Economy and Market: Share buybacks can have broader economic and market impacts. For example, if a company uses debt to finance buybacks, it can contribute to overall corporate debt levels in the economy. Additionally, if buybacks are seen as a short-term tactic to boost stock prices without addressing underlying issues, it could lead to market volatility and create concerns about market manipulation. On the other hand, if buybacks are viewed positively by investors, they may boost overall market sentiment and potentially attract more investment.
- Other Stakeholders: Share buybacks can also impact other stakeholders, such as creditors, suppliers, and customers. For example, if a company uses debt to fund buybacks, it may impact its credit rating, which could affect its ability to borrow money in the future. Additionally, if a company prioritizes buybacks over reinvesting in its operations or paying suppliers or employees, it could impact relationships with these stakeholders and have broader implications on the company’s operations and reputation.
Example of Share buyback:
Company ABC is a publicly traded company that manufactures consumer electronics. Over the past few years, the company has accumulated a significant amount of cash on its balance sheet due to strong sales and profitability. The company’s board of directors decides that it would be beneficial to return some of the excess cash to shareholders through a share buyback program.
Company ABC announces a share buyback program of up to $1 billion, which represents approximately 10% of its outstanding shares. The buyback will be conducted over the next 12 months through open market purchases.
Over the course of the year, Company ABC uses its available cash to buy back its own shares in the open market. The company repurchases a total of 5 million shares at an average price of $200 per share, spending a total of $1 billion. These shares are retired and no longer considered outstanding, which means that the ownership percentage of existing shareholders increases.
As a result of the share buyback, the company’s outstanding shares decrease from 50 million to 45 million shares. This reduction in the number of shares outstanding results in an increase in earnings per share (EPS) and other financial ratios, as the same amount of earnings is spread among fewer shares.
Additionally, the shareholders who sold their shares to the company through the buyback program receive cash in exchange for their shares, which they can use for other purposes, such as reinvesting in other investments or using for personal expenses.
Overall, share buybacks can be a useful tool for companies to manage their capital structure and return value to shareholders, but they should be carefully considered and executed with a long-term perspective in mind to ensure they align with the company’s strategic objectives and create sustainable shareholder value.
