Tata Consultancy Services Ltd (TCS), India’s largest information technology services provider, at its meeting held on June 15, 2018 announced a mega Rs 16,000 crore buyback. The company would repurchase up to 76 million (76,190,476) Equity Shares of the Company for an aggregate amount not exceeding Rs 16,000 crore, at Rs. 2,100 per Equity Share. The buyback is around 2% of the total paid up equity share capital. The buyback price has been fixed at Rs 2,100 a share, a 15% premium over its current market price.
TCS has proposed the tender offer route to buy back its equity shares under. This is the second year in a row when TCS has decided to go for buyback of shares in a bid to return excess cash to its shareholders. Last year in May, TCS had undertaken Rs 16,000-crore buyback offer entailing around 5.6 crore equity shares at a price of 2,850 per scrip.
According to Sebi regulations, 15 per cent of the offer size — that is, Rs 2,400 crore in this case — will be reserved for small shareholders holding shares up to a value of Rs 2 lakh as on the record date. The 15 per cent reserved shares would mean retail investors can tender 1.14 crore shares.
This should ideally have had almost no impact on the company’s share price, given the small reduction in the company’s share capital. But the TCS stock rose 3% after the share buyback announcement, largely because of a peculiarity in India’s share repurchase rules. Since 2016, TCS’s FY19 earnings estimates have been cut 13%, but its shares are still up by 38%.
The Securities and Exchange Board of India, or Sebi, has mandated that companies reserve 15% of share buyback offers for small shareholders with holdings worth less than Rs 2 lakh.
These shareholders typically own a fraction of the company’s shares, which essentially means that all or most of the shares they tender in buyback offers get accepted. This provides an incentive for short-term trades that involve buying shares worth Rs 2 lakh or so just ahead of the buyback, and then tendering them at the announced buyback price, which in this case is at a 17% premium.
Rationale for buyback
Often companies go for buyback in order to use the excess cash generated by the business. Further, a buyback announcement could send a positive signal to the stock market that the management have enough confidence in the future performance of their company. It can also be seen as an indirect way of enhancing the controlling stake in the company. The shares bought under this schema are shown in the balance sheet as a treasury stock. This stocks could be resold whenever the need arises or could be used for employee stock option scheme. By means of buyback the promoters indirectly increase their stake in the company.
However, not all buyback offers are good. There are various evidence available across countries and markets that buybacks sometimes are a short-cut way to increase the price. Therefore, as an investor, one should look at the size of the buyback.
Should you go for it?
The buyback will be over and above Rs 29 per share final dividend declared for 31st May FY18. This implies that during FY19 the company will return Rs 27,100 crore cash to shareholders. This buyback expects neutral Earning per share (EPS) with just 2% reduction in equity share capital. However, it sees profit before tax (PBT) impact of -2.3% on lower other income. Return on equity (ROE) may improve by 200 bps.
TCS would buyback 2% of equity shares. It would be spending 33% of cash on balance sheet for buyback. As per the sebi norm 15% of the buyback (lesser than Rs 2 lakh in value) would be allocated for retail. As per annual report 2018 TCS has 32.9 mn shares in this retail category. We note that TCS is buying back 76 mn shares. This implies for retail 11.4 mn of shares would be allocated. Assuming all the shareholders in Retail, promoter and institution surrender all shares. Only 1.7% would be Institutional acceptance. We assume that promoter will participate in this buyback similar to the previous buyback. For promoter group and retail category this buyback would be beneficial.
Like the previous buyback, Sebi has mandated that companies reserve 15 per cent of the buyback for small shareholders with holdings worth less than Rs 2 lakh. Therefore in this buyback too, for small retail investors the acceptance ratio is likely to be high. It implies depending on how much the promoter is tendering, a lesser acceptance ratio for institutional holders.
From the perspective of retail investor, the investors should continue to stay and not get out in a hurry because it is not that a lot of your shares being bought back, especially if the promoters were to participate. The stock may continue to do well as long as there is growth. If at all the situation becomes worse, the technology sector can only get better.