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International Journal of Advanced Scientific

e-ISSN: 2395-6089
Research & Development
Vol. 03, Spl. Iss. 03, Ver. I, Sep 2016, pp. 135 140

p-ISSN: 2394-8906

Evaluating a Corporate Buyback

Dr. M. SHARMEEN FAROOQ
Senior Assistant Professor, Ethiraj College for Women, Chennai.

ARTICLE INFO

ABSTRACT

Article History:

Buyback of shares by companies is a relatively new concept

in India. A stock buyback popularly known as a "share
repurchase" is the act of a company's buying back its shares
from the marketplace. Buyback by a company is investing
in itself are innovative ways in todays scenario to reward
the investors. But the vision for the stakeholder is that a
business should be measured by its true value and use true
costs and true profits in its internal and external reporting.
Here valuation provides a road map to increasing a firms
future growth, helping to recognise what adds to its worth
by improving future business decisions. At this juncture, it
is necessary to study the impact of the buyback on the
companys financials. It is essential to know to what extent
a business in its share buyback creates value. This is
because value creation is the ultimate measure of
performance. For analysing a firm, it is imperative to
recognize the changes in capital structure, the value per
share and the extent of changes on Earnings per share due
to buyback. In this paper, an attempt is made to
incorporate financial data to study the impact of buyback.

Received: 26 Sep 2016;

Accepted: 26 Sep 2016;
Published online: 28 Sep 2016.

Key words:
Share buyback,
Value per share,
Earnings per share

JEC Classification:

Copyright 2016 IJASRD. This is an open access article distributed under the Creative Common Attibution
License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original
work is properly cited.

INTRODUCTION
Share buybacks are a rage today. For most of the stock market's history,
buybacks were actually illegal and considered to be insider trading as the use of non
public information to buy shares was considered inappropriate. In 2004, the companies
announced plans to repurchase Rs. 230 billion in stock which was more than double the
volume of the previous year. During the first three months of that year the buyback
announcements exceeded Rs.50 billion. Indian firms bought back shares worth over Rs
1,700 crores from public in 2015-16, achieving 97% of the target. Nearly 15 buyback
offers were concluded in the last fiscal year with a total acquired sum of Rs 1,713 crores.
And with large global corporations holding trillions in cash, all the signs today indicate
that buybacks and other forms of payouts will accelerate.
How to cite this article: Farooq, S. M. (2016). Evaluating a Corporate Buyback. International Journal of Advanced
Scientific Research & Development (IJASRD), 03 (03/I), [Special Issue Sep 2016], pp. 135 140.

Emerging Innovative Strategies in Business Creating a Competitive Edge | Organized by PG

Department of Banking & Insurance Management and Department of Bank Management,
Ethiraj College for Women (Autonomous), Chennai 600 008.

Companies in emerging markets like India often face additional risks, relative to
their developed market counterparts, from political and economic turmoil in the
countries in which they operate. In the current scenario, the provisions regulating buy
back of shares are contained in Sections 77A, 77AA and 77B of the Companies Act,
1956. These were later inserted by the Companies (Amendment) Act, 1999. The
Securities and Exchange Board of India (SEBI) also framed the SEBI (Buy Back of
Securities) Regulations, 1999. Buybacks have started gaining momentum after the
10% tax on investors' earning dividends above Rs 10 lakhs came into effect on April 1,
2016. In the Budget 2016, the government imposed a 10% tax on dividend income of
over Rs 10 lakhs. Since then, six large pharmaceutical companies have announced a
buyback of shares worth Rs 10,650 crores, which is in sharp contrast to last year, when
the total value of shares bought back was Rs 650 crores.
The past few months have seen several companies offering to buy back their
equity through either open-market purchases or tender offers. In the last six months
Companies have announced Rs 7,800 crores worth of buybacks. For shareholders, the
big question is: should one sell holdings in the market to benefit from a buyback? In the
case of buyback repurchased shares are absorbed by the company and the number of
outstanding shares on the market is reduced. As a result the relative ownership stake of
each investor increases because there are fewer shares, or claims, on the earnings of the
company.
A buybacks is carried out in one of two ways. The shareholders may be presented
with a tender offer by the company to tender, a portion or all of their shares within a
certain time frame. The tender offer will stipulate both the number of shares the
company is looking to repurchase and the price range that they are willing to pay which
is mostly at a premium to the market price. The second alternative a company has is to
buy shares on the open market at the market price.
Sun Pharmaceutical Industries Ltd is Indias largest, most trusted, and most
valuable pharmaceuticals company by market capitalisation with global revenues
exceed US$ 4.6 billion. It is also the fifth largest speciality generic pharmaceutical
company in the world. But in the past two years, apart from the dividend income,
investors of Sun Pharmaceutical Industries have had little to cheer. In August 2014, the
company's stock price was around Rs 780, though the stock momentarily touched Rs
900, it has fallen back to Rs 780 which happens to be the current price. Understanding
the plight of its shareholders, Sun Pharma has now announced a buy-back of its share
at a price of Rs 900 on a proportionate basis through the tender process. The buyback
was for 7.5 million shares, which represented 3.79 per cent of the paid up capital. The
offer would cost the company Rs 675 crores and help increase the promoters share in
the company from 54.97 per cent to 55 per cent.
1.1 Objectives of the Study
The following are envisaged as the objectives of the study:
1. To examines a number of relevant issues concerning buyback of shares including
the psychological impact of buyback on the investors.
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Evaluating a Corporate Buyback

2. To evaluate the effect of a buyback on EPS and value per share.

1.2 Data Collection
The financial data for the company has been collected from its financial
statements and stock price data is from the website moneycontrol.com. The risk free
rate and Equity Risk premium are the computed figures for India from Professor
Aswath Damodaran, Professor, Stern School of Business, New York, USA. The analysis
has been performed with the help of a model developed by him to assess how a buyback
will affect earnings per share and make judgments on its consequences for overall value
and value per share.
Table 1: Analyzing the Effect of a Share Buyback Excluding Tax Pre-Buyback
Details
(in Rs. Millions)

Current Stock price =

Rs. 752.60

Shares outstanding before buyback =

Rs. 214830.90

Beta for the stock =

0.28

Debt outstanding =

Rs. 38,673.90

Cash and marketable securities =

Rs.1,693.90

Cost of debt =

7.59%

Net Income

Rs. 47,159.10

Interest income from cash

Rs. 231.20

Fair estimate of stock value

Rs.130.00

Buyback Information
(in Rs. Millions)

Expected buyback price =

Rs. 900.00

Number of shares bought back =

7.50 millions

Funded with cash =

Rs.7.50

Funded with new debt =

Rs.60.00

Cost of new debt =

7.59%

Risk free Rate =

7.19%

Equity Risk Premium =

9.71%

Marginal tax rate =

12.50%
Table 2: Value Impact
(in Rs.Millions)

Pre-buyback
Beta

Post-buyback

0.28

0.28

Debt to Equity Ratio

0.02%

0.02%

Debt to Capital Ratio

0.02%

0.02%

Cost of equity

9.91%

9.91%

137

% Change

Volume 03, Special Issue 03, Version I | 28th September 2016

Emerging Innovative Strategies in Business Creating a Competitive Edge | Organized by PG

Department of Banking & Insurance Management and Department of Bank Management,
Ethiraj College for Women (Autonomous), Chennai 600 008.

After-tax cost of debt

6.64%

6.64%

Cost of capital

9.91%

9.91%

Enterprise value

Rs.16,17,18,715.34 Rs.16,17,18,735.48

0.00%

Firm value

Rs.16,17,20,409.24 Rs.16,17,20,421.88

0.00%

Debt outstanding
Equity value

Rs.38,673.90

Rs.38,733.90

0.16%

Rs.16,16,81,735.34 Rs.16,16,81,687.98

0.00%

Number of shares

214830.90

214823.40

0.00%

Price/share

Rs.752.60

Rs.752.63

0.00%

Table 3: Value Transfer

(in Rs. Millions)

Value per share pre-buyback (if available) =

Rs.130.00

Price on buyback =

Rs.900.00

Number of shares bought back =

7.50 millions

Value transfer to remaining shareholders =

-Rs.5,775.00

Remaining shares =

214823.40

Value transfer per remaining share =

-Rs.0.03

Price per share with value transfer =

Rs.752.60

Table 4: EPS Impact

(in Rs. Millions)

Pre-buyback
Market capitalization
Price per share
Net Income
Earnings per share

Post-buyback

Rs.16,16,81,735.34 Rs.16,16,81,687.98

% Change
0.00%

Rs.752.60

Rs.752.63

0.00%

Rs.47,159.10

Rs.46,923.92

-0.50%

Rs.0.22

Rs.0.22

-0.50%

The above tables indicate the impact of the share buyback on value per share and
EPS. When a company announces a buyback it is usually perceived by the market
positively which often causes the share price to increase. The goal of a firm's
management is to maximize return for shareholders and a buyback generally increases
shareholder value. Another reason a company might pursue a buyback is solely to
improve its financial ratios upon which the market seems to be heavily focused. The
buyback also helps to improve the company's price-earnings ratio (P/E). The P/E ratio is
one of the most well-known and often-used measures of value. At the risk of
oversimplification, when it comes to the P/E ratio, the market often perceives the lower
P/E to be better.
The Sun Pharma buyback has not been very effective with poor acceptance of the
offer. Since the companys operations dont change, its return on operating capital is the
same after the buyback. The companys earnings fall as a result of losing the interest
income, the change of EPS is a purely mechanical effect that is not linked to
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Evaluating a Corporate Buyback

fundamental value creation. Also not much positive effect on price has been observed.
But if the corporate taxes become a part of the equation, the companys value would
increase as a result of share buybacks although only with a small amount as its cost of
capital falls from having less cash or greater debt. The cost of capital is lower when a
company uses some debt for financing, because interest payments are tax deductible
while dividends are not. Holding excess cash raises the cost of capital: since interest
income is taxable, a company that maintains large cash reserves puts investors at a
disadvantage.
Although not in the current case, but generally buybacks create value because
they help improve tax efficiency and prevent managers from investing in the wrong
assets or pursuing unwise acquisitions. In general, having too much cash on hand
penalizes a company by increasing its cost of financing. The share price increases from a
buyback in theory results purely from the tax benefits of a companys new capital
structure rather than from any underlying operational improvement. Generally on an
average there is an increase in their share price of 2 to 3 percent on the day of the
announcement and those who undertake larger buybacks, involving around 15 percent
or more of the shares, have price increases by 16 percent.
1.3 Psychological Impact of Buybacks
The market responds to announcements of buybacks because they offer new
information, often called a signal, about the future of a company and its share price.
One vital positive signal in a buyback is that the management believes that the stock is
undervalued. Executives can enhance this effect by personally purchasing large number
of shares, since market participants look at them as de facto insiders with privileged
information about future earnings and growth prospects. A second positive signal is
managements confidence is that the company doesnt need the cash to cover future
commitments such as interest payments and capital expenditures.
The third, negative signal with a buyback is that the management team suggests
to investors instead of the few investment opportunities in the company they could do
better by investing their money elsewhere. The strength of the markets reaction implies
that shareholders often realize that a company has more cash than it can invest long
before its management does.
The overall positive response to a buyback results from investors being relieved
that managers arent going to spend a companys cash on mergers and acquisitions or on
projects with a negative net present value. In many cases, a company seems to be
undervalued just before it announces a buyback, reflecting an uncertainty among
investors about what management will do with excess funds.
CONCLUSION
Boards and executives should understand the difference between fundamental
value creations through improved performance as purely mechanical effects of a
buyback program on EPS will not help to create value. Investors should focus on wealth
creation by investing right rather than making speculative profits on buyback of shares.
139

Volume 03, Special Issue 03, Version I | 28th September 2016

Emerging Innovative Strategies in Business Creating a Competitive Edge | Organized by PG

Department of Banking & Insurance Management and Department of Bank Management,
Ethiraj College for Women (Autonomous), Chennai 600 008.

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