Understanding Share Buyback: Benefits, Risks, and its Financial Impact

• In a share buyback, companies repurchase their outstanding shares from shareholders.
• Share buybacks increase promoters' control and enhance earnings per share (EPS).
• The key advantages of share buyback include efficient use of cash reserves, protection against hostile takeovers, and positive growth prospects.
• Some drawbacks of share buyback include potential miscalculation of company valuation and delays in major investment projects.

Reasons for Buyback

1. Share buybacks lower the capital base, leading to higher earnings per share (EPS).
2. It acts as a defense mechanism against corporate takeovers by increasing promoters' holdings.
3. Buybacks provide flexibility by allowing companies to reduce their equity base when necessary.
4. They reduce the floating stock ratio, increasing the shares' intrinsic value.
5. Repurchases allow businesses to expand their capital bases without raising additional funds through mergers and acquisitions.

Different Methods of Share Buyback

1. Buying from the Open Market

• The company purchases its own shares from the market through brokers.
• Buyback programs may last for an extended period and can be modified based on business requirements.

2. Tendering

• The firm issues a tender to buy shares from existing shareholders at a fixed price, usually above the current market value.
• The buyback proceeds are based on investor participation.

3. Repurchase by Direct Negotiation

• Companies negotiate directly with major shareholders, offering a price higher than the existing rate.

4. Dutch Auction Tender Offer

• Instead of a fixed price, a price range is offered, allowing investors to place bids within that range.

Financing Aspects of Buyback

• Internal funding from profits
• Maintaining adequate cash reserves
• Selling short-term investments
• Issuing fixed deposits, loan bonds, or debentures
• Loans and overdraft facilities from banks

Share Buyback vs. Dividend

Impact of Share Buybacks on Financial Metrics

Advantages of Share Buyback

1. Efficient use of excess cash reserves.
2. Alters capital structure, balancing equity commitments.
3. Signals confidence in the company's future prospects.
4. Provides a defense against hostile takeovers.
5. Increases promoter control over the company.
6. Enhances EPS and P/E ratios.
7. Helps firms with high liquidity optimize capital use.
8. Leads to higher dividend yields post-buyback.

Disadvantages of Share Buyback

1. EPS and ROA ratios may rise artificially due to reduced shares rather than increased profitability.
2. Misjudgment of company valuation by management could lead to ineffective buybacks.
3. May hinder major investment projects by utilizing cash reserves.
4. Can be used unethically to increase promoter holdings.

Regulatory Measures Governing Share Buyback

• Maximum buyback limits and methods (tender offer or open market).
• Cooling-off periods before another buyback can be initiated.
• Solvency requirements and shareholder disclosure obligations.

Conclusion