why do listed companies buyback common equity? - some analysis from india

Why do listed companies

buyback common equity?Some analysis from India

The basics of buybacks

Executive management may propose a buyback of equity to board

Board/Board committee deliberates and passes a resolution

Certain buyback programs will require shareholder approval

Key parameters for a buyback program -

A. Maximum number of shares that can be bought back

B. Maximum amount of capital that can be spent for buying back shares

C. Maximum price that can be paid for buying back a share

D. Start and End date for buyback program

E. Class of equity

F. Method of buyback: Open market/Tender/Accelerated(US)

Neeladrinath Sarangi, HKU MBA

Mechanics of a buyback program

There are typically, regulatory limits on some of the parameters -

A. Upto 25% of fully paid-up shares may be repurchased

B. Upto 25% of equity capital (and free reserves) may be spent on buying back securities. If greater than 10% is to be spent, shareholder approval is required.

C. A buyback program may extend over a maximum of 12 months (reduced further)

D. A buyback program deals with only a single class of equity

E. A buyback program cannot be launched within 12 months of a previous program

Backdoor entry for increasing promoter shareholding/delisting – not granted!?

Debt covenants dealing with leverage may limit buyback size

Buyback may be financed by share premium, free reserves and other classes of equity capital


Equity capital history

DateClass of

shares

No. Of

sharesFace Value $ Premium $

No. of

shareholders

Jan 2000 Class A 100 10 0 9

Jan 2000 Class A 85 10 0 7

Mar 2002 Class B 5 200 0 2

Mar 2002 Class B 5 200 100 2

Sep 2006 Class A 1,000,000 10 110 7

Oct 2006 Class A 500,000 10 120 5

Oct 2006 Class A 200,000 4 50 2

Jul 2007 Class A 10,000,000 10 130 49

Jul 2007 Class A 10,000,000 10 135 40

HKU MBA & Company

Date (all in $,

except Date)

Class A

equity (FV)

Class B

equity (FV)

Class A

equity(Prem)

Class B

equity(Prem)

Retained

earnings

Jan 2000 850 0 0 0 0

Mar 2002 850 1,000 0 500 10M

Oct 2006 5,800,850 1,000 70,000,000 500 100M

Jul 2007 105,800,850 1,000 1,420,000,000 500 1000M

Offered equity Paid-up equity Equity raising

Date (all in $,

except Date)

Class A Fully

Paid-up

Class A Partly

Paid-up

Class B Fully

Paid-up

Class B Partly

Paid-up

Jan 2000 850 0 0 0

Mar 2002 850 0 1,500 0

Oct 2006 65,000,850 10,800,000 1,500 0

Jul 2007 1,515,000,850 10,800,000 1,500 0

Promoters & associates 2nd round promoter infusion with superior rights

2nd round with existing Class A shareholders A public company; equity investment by new shareholders

Shares may be repurchased via

private agreements thus far


Equity capital history

DateClass of

shares

No. Of

sharesFace Value $ Premium $

No. of

shareholders

Nov 2010 Class A 50,000,000 10 140>49,

Everybody

Dec 2010 Class A 50,000,000 10 100 1,000,000

HKU MBA & Company

Date (all in $,

except Date)

Class A

equity (FV)

Class B

equity (FV)

Class A

equity(Prem)

Class B

equity(Prem)

Retained

earnings

Dec 2010 605,800,850 1,000 6,420,000,000 500 10B

Offered equity Paid-up equity Equity raising

Date (all in $,

except Date)

Class A Fully

Paid-up

Class A Partly

Paid-up

Class B Fully

Paid-up

Class B Partly

Paid-up

Dec 2010 7,015,000,850 10,800,000 1,500 0

Initial Public Offering

1.1 0.8

2.3

0.5

5.3

Retained earnings

Revaluationreserve

Translation reserve

Contingencyreserve

Remunerationreserve

Remaining

Maximum buyback size determination for common stock (Class A)

Capital limit:

Fully paid-up capital = (7,015,000,850+1,500) = 7,015,002,350

Free reserves = 5,300,000,000

25% of fully paid-up capital and free reserves = 0.25 * 12,315,002,350 = $ 3,078,750,587.50

Securities limit:

Number of fully paid-up class A shares = 60,500,085

25% of number of fully paid-up class A shares = 15,125,021.25 shares

Hence upto 15,125,021 shares may be repurchased using upto $ 3,078,750,587.50

Structuring a buyback

Shares may be repurchased only via

regulated transaction when listed


The Holy trinity of a buyback

Buyback

Buyback Price

Buyback size

Number of

shares


Visualizing the buyback

X axis: Range of buyback price

Xmin = $100; Xmax = $200

Y axis: Number of shares repurchased

Ymin = 0 shares; Ymax = 15,125,012 shares

Z axis: Capital utilized in buyback program

Zmin = $0; Zmax = $ 3,078,750,587.50


Xmin = $100; Xmax = $300




Zmin = $0; Zmax = $ 3,078,750,587.50


Xmin = $100; Xmax = $600




Zmin = $0; Zmax = $ 3,078,750,587.50

Successful buyback Partially “successful” buyback An even lesser “successful” buyback

Software by http://www.math.uri.edu/Neeladrinath Sarangi, HKU MBA


Maximum buyback price usually based on price levels over the weeks leading

upto the management recommendation

Too high – remaining shareholders penalized

Too low – poor acceptance rate, viewed unfavorably

Buyback not permitted if there are pending dues/unmet obligations and likely

default in the following year

Buybacks cannot be launched when there is an issuance of the same class of

equity capital, a scheme of amalgamation or restructuring.



Withdrawal of buyback program not permitted after public announcement.

Controlling shareholder and insiders cannot deal in equity securities after

passage of buyback resolution except as part of buyback.

Escrow account

a. Security for performance of obligations

b. POA to manager of the buyback

c. Used to collect penalties in case of contingencies

Repurchased equity is extinguished/added to treasury stock


Consequences & costs of a buyback

program

No further capital raising by issue of same class of equity for 6mo/24mo

Corporate actions such as stock splits, bonus issue of shares and other

transactions affecting equity capital cannot be initiated during the buyback

program

No new buyback programs for 12mo from close of previous, unless shareholder

approval / 100% utilization

Appointment of financial intermediaries – manager of the buyback, banks

Auditor involvement & fees; Coordination with share registrar

Compliance officer with supporting staff

Director & other transaction party liabilities; Due Diligence responsibilities


Consequences & costs of a buyback

program

Preparation and filing of offer documents, printing, dispatch of letters and

forms to shareholders; processing of received tenders (for tender buybacks)

Escrow commitment (~25%, graded by size; Cash+BG+Liquid Secs)

Periodic disclosures (SE announcements & SE+Secretarial filings) on actual

repurchases; Significant administrative costs

Other disclosures: not repurchasing proportionate quantity (open market

buybacks)

Controlling shareholder declarations – intention & recent transactions

Failure of transaction if disclosed minimum not achieved; Minimum usually set

as 0 shares


Different methods of buyback of listed

equity

Share buyback

Open Market method

Stock Exchange

Book building

Tender method

Tender

If buyback size ≥15%

of paid-up equity

capital + Free

reserves

Privately

negotiated

transactions/

Block deal/

Bulk deal/ Off-

market


The Tender method of buyback

Entitlement on a proportionate basis

15% reservation for small shareholders

15%

85%

34

20

30

10

6

SHP, Number of shares

Con.SH

SH1

SH2

SSH1

SSH2

Shareholder CategoryHolding on

record dateEntitlement Max tender

Con. SH Other 34 7 (35%) 34

SH1 Other 20 4 (20%) 20

SH2 Other 30 6 (30%) 30

SSH1 Small 10 2 (10%) 10

SSH2 Small 6 1 (5%) 6

Total 100 20 80

Buyback of 20 shares

Buyback of

20% of

common

equity

The Tender offer

15% of

buyback size =

3 shares


The Open Market method of buyback

Stock Exchange:

Company opens share account with stock broker (usually the brokerage

business of the manager of the buyback)

Company management is advised by the manager of the buyback and

repurchases shares

The repurchase transactions are done just as other transactions on the “floor”

of the exchange

Daily/Weekly reporting of actual repurchases via stock exchange

announcement by the company after close of the day’s trading

Until recently, no legal/regulatory penalty to force repurchase of shares after

buyback launch; Now 50% is mandatory, some force majeure exceptions



Book building:

Shareholders as on record date, invited to bid on their holdings

Actual/Final buyback price determined after book has been built

ShareholderHolding on

record dateBid quantity Bid price $

Con. SH 34 9 10.00

SH1 20 4 9.95

SH2 30 22 11.05

SSH1 10 4 10.05

SSH2 6 5 9.90

Total 100 44

Bid price $ Bid quantityAccepted

quantityShareholder

9.90 5 5 SSH2

9.95 4 4 SH1

10.00 9 9 Con. SH

10.05 4 2 SSH1

11.05 22 0 SH2

Total 44 20

Bidding Book building

Shareholder Repurchased Price $Consideration

$

SSH2 5 10.05 50.25

SH1 4 10.05 40.20

Con. SH 9 10.05 90.45

SSH1 2 10.05 20.10

Total 20 10.05 201.00

Buyback results

Buyback of 20 shares, Maximum price: $10.50;

Buyback size: $250.00

Ascending



Book building:

Limiting of successful bids by number of shares, maximum price or consideration

Bid price $ Bid quantityAccepted

quantityShareholder

9.90 5 5 SSH2

9.95 4 4 SH1

10.00 9 9 Con. SH

10.05 4 2 SSH1

11.05 22 0 SH2

Total 44 20

Book building

Shareholder Repurchased Price Consideration

SSH2 5 10.00 50.00

SH1 4 10.00 40.00

Con. SH 9 10.00 90.00

SSH1 0 0 0.00

Total 18 10.00 180.00

Buyback resultsAscending



Shareholder Repurchased Price Consideration

SSH2 5 10.00 50.00

SH1 4 10.00 40.00

Con. SH 1 10.00 10.00

SSH1 0 0 0.00

Total 10 10.00 100.00



Buyback results


Stock price movement over the buyback

period

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1 91 181

Sca

led

to A

ver

age

pri

ce o

n o

pen

date

Trading days from Buyback offer open date

Price movement in major buyback programs in FY2010 & FY2011; Each colour represents an

open market- stock exchange buyback program

Price rallies in

the months

following the

launch


Relationship between HPR and

Completion rate

0%

20%

40%

60%

80%

100%

120%

140%

-100% -50% 0% 50% 100% 150% 200%

Co

mp

leti

on

ra

te

HPR

LOESS

Sample

Pertains to Open market-stock exchange buyback programs from Apr 1, 2007 to Jan 31, 2013

HPR: Holding period return (proxy for trend of share price during buyback period); LOESS: Locally weighted scatter-plot smoothing



Completion rate

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.69793

R Square 0.487106

Adjusted R Square 0.460111

Standard Error 0.262575

Observations 21

ANOVA

df SS MS F Significance F

Regression 1 1.244098 1.244098 18.04467 0.000435

Residual 19 1.309964 0.068945

Total 20 2.554063

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 99.0% Upper 99.0%

Intercept 0.623523 0.059303 10.51414 2.33E-09 0.4994 0.747646 0.45386 0.793185

HPR -1.01475 0.238883 -4.2479 0.000435 -1.51474 -0.51476 -1.69818 -0.33132

The ANOVA results indicate that although the regression could explain only 46.01% of the relationship in the HPR range [-50%,+25%], there

is a strong, significant relationship as evidenced by F and t Stats of Intercept and HPR being beyond Significance F and Lower 99.0% and

Upper 99.0% of Intercept and HPR respectively.



Completion rateS.No HPR Compl R HPR Rank

Compl R

Rankd dsq

1 -68.92% 11.56% 1 5 -4 16

2 -26.19% 100.00% 2 28 -26 676

3 -25.81% 100.00% 3 29 -26 676

4 -16.66% 100.00% 4 27 -23 529

5 -13.58% 100.00% 5 26 -21 441

6 -11.05% 49.80% 6 17 -11 121

7 -10.75% 94.48% 7 24 -17 289

8 -10.47% 12.79% 8 6 2 4

9 -7.93% 50.97% 9 18 -9 81

10 -6.23% 33.13% 10 13 -3 9

11 -0.45% 100.00% 11 30 -19 361

12 0.35% 98.04% 12 25 -13 169

13 1.05% 64.48% 13 22 -9 81

14 3.15% 58.62% 14 21 -7 49

15 3.46% 66.43% 15 23 -8 64

16 7.42% 29.16% 16 11 5 25

17 30.46% 6.73% 17 2 15 225

18 36.18% 18.20% 18 9 9 81

19 38.08% 31.33% 19 12 7 49

20 43.95% 6.38% 20 1 19 361

21 45.24% 9.62% 21 3 18 324

22 54.18% 42.85% 22 14 8 64

23 57.19% 49.59% 23 16 7 49

24 59.59% 52.03% 24 19 5 25

25 73.82% 14.42% 25 7 18 324

26 85.74% 58.26% 26 20 6 36

27 139.40% 18.48% 27 10 17 289

28 149.89% 10.91% 28 4 24 576

29 155.46% 46.54% 29 15 14 196

30 155.74% 15.29% 30 8 22 484

Sum 6674

Spearman’s rank correlation coefficient -0.4848

t value -2.9327

p value 0.9935

Null hypothesis Rejected

The test results indicate that the probability that the

null hypothesis (Spearman’s coefficient = 0; There is no

correlation between HPR and Compl R) is true is 0.65%.

We may thus assume that there is a strong negative

correlation between HPR and Compl R. In other words,

the holding period return over the buyback period and

completion rate of the buyback are inversely related.

Increase in prices are linked to lesser amounts deployed

in actual share repurchases.

Compl R: Completion rate


Why do listed companies buyback their

equity?

Stated management rationale for buyback – the usual reasons!

“Company’s stock is undervalued”

“Improvement in EPS, ROE and other vital metrics”

“Returning excess cash to shareholders”

“Maximize shareholder value”

…

…

etc


Looking at the data...

April 1, 2004 March 31, 2012


The stats

155 buyback programs were announced over the period.

86.5% of all buybacks were via open market route.

Average size of buybacks was INR 189.45 Cr. If RIL’s INR 10,440 Cr buyback in

2012 is not included, average size is INR 122.89 Cr.

Average size of buybacks via tender route was INR 172.18 Cr, while that via

open market route was INR 115.11 Cr. The RIL 2012 buyback has not been

considered for this statistic.

Average completion rate of buybacks was approximately 62.63%.

Average completion rate of buybacks via tender route was 85.09%, while that

via open market route was 58.74% approximately.

1 Crore

= 10 Mn

Source: Analysis of data from Bloomberg, PRIME Database and company filings


The sample sets

Listed companies with market capitalization > INR 100 Cr as of Mar 31, 2012

Split into three sample sets

NBB

•Never announced buyback program

•126 firms

BBN

•Announced atleast one buyback

•Observations pertaining to the year of the buyback announcement

•25 firms

BBY

•Announced atleast one buyback

•Observations pertaining to the year(s) other than those with the buyback announcement(s)

•25 firms

Financial data from FY05 to FY12

1 Crore

= 10 Mn


Base set characteristics


48%

11%

23%

17%

Sample composition by 2012 Mcap

Microcap Smallcap Midcap Largecap

66

176

226

210

24

70

8821

158

41

0 1

40

124

0

50

100

150

200

250

Micro Small Midsized Large

Num

ber

of

firm

s in

sam

ple

2012 Revenue (INR Cr)

Microcap Smallcap Midcap Largecap

BB and NBB sample sets selected from base set

Sample of non-buyback firms

-20,000

-15,000

-10,000

-5,000

0

5,000

10,000

15,000

20,000

25,000

30,000

-1,00,000 -50,000 0 50,000 1,00,000 1,50,000 2,00,000 2,50,000 3,00,000 3,50,000 4,00,000 4,50,000

2012 N

et

Incom

e (

INR C

r)


NBB Firms

Bubble size: 2012 Market cap (INR Cr)


Sample of buyback firms

-500

0

500

1,000

1,500

2,000

2,500

3,000

3,500

-5,000 0 5,000 10,000 15,000 20,000 25,000 30,000

2012 N

et

Incom

e (

INR C

r)


BB Firms

Bubble size: 2012 Market cap (INR Cr) Note: RIL not included in this representation.


Market trend and buyback

announcements

0

2

4

6

8

10

12

0

1,000

2,000

3,000

4,000

5,000

6,000

Apr 2004 Apr 2005 Apr 2006 Apr 2007 Apr 2008 Apr 2009 Apr 2010 Apr 2011

Buyback a

nnouncem

ents

CN

X 5

00

Buyback announcements CNX 500


Buybacks - Industry breakdown

Industry Size (INR Cr) % Number % Average Size (INR Cr) Avg Size rank

Diversified 13,863.84 47% 10 6% 1,386.38 1

Pharmaceuticals 3,428.67 12% 18 12% 190.48 3

Energy 2,917.96 10% 6 4% 486.33 2

FMCG 1,509.97 5% 8 5% 188.75 4

Construction & real estate 1,491.72 5% 9 6% 165.75 6

Media 1,257.66 4% 9 6% 139.74 7

Automobiles 1,076.17 4% 6 4% 179.36 5

Materials 848.39 3% 17 11% 49.91 11

Chemicals 750.07 3% 12 8% 62.51 8

Information Technology 557.97 2% 18 12% 31.00 15

Financial services 507.66 2% 12 8% 42.31 13

Capital goods 409.21 1% 10 6% 40.92 14

Telecommunications 382.61 1% 9 6% 42.51 12

Jewellery 158.62 1% 3 2% 52.87 9

Logistics 87.33 0% 3 2% 29.11 16

Electrical & Electronics 66.86 0% 4 3% 16.72 17

Other 50.00 0% 1 1% 50.00 10

Total 29,364.71 155


Buybacks - Industry breakdown

The majority of share buybacks in India are by a few firms in a few industries. There are some firms which pursue buybacks every few

years.

Industry Number of serial

Buybacks

Firm 1 Firm 2 Firm 3 Firm 4

Diversified 7 SRF Reliance Inds Bhagyanagar Ind Ltd

Pharmaceuticals 9 FDC GSK Amrutanjan Abbott India

Energy 4 R Infra

FMCG 5 Godrej CP HUL

Construction & real estate 2 Rain Commodities

Media 4 Deccan Chronicle ETC Networks

Automobiles 0

Materials 7 Jindal Polyfilms HEG Monnet Ispat

Chemicals 5 ICI India GeeCee Ventures

Information Technology 6 Mastek Avantel Softsol

Financial services 8 Indiabulls CRISIL India Infoline Apollo Finvest

Capital goods 2 AveryIndia

Telecommunications 6 MRO-TEK Sasken Valiant

Jewellery 2

Goldiam

International

Logistics 2 Aegis Logistics

Electrical & Electronics 0

Other 0



equity?

Is it to do with Cash? Are buybacks initiated by companies

with high cash levels or excess cash?


Cash levels and Buybacks

Distribution

parameterBBY BBN NBB

Q1 0.44% 1.00% 0.82%

Q3 6.00% 5.00% 4.80%

Mean 1.74% 2.51% 2.35%

Count 24 79 563

Unadj Skew 1.77 3.74 4.22

Unadj Kurtosis 2.78 17.86 25.06

Unadj Mn 2.53% 4.18% 4.02%

Skew 0.90 0.52 0.38

Kurtosis 0.08 -0.87 -0.95

Separate variance t test Paired t test

BBY NBB BBY BBN

Mean 1.74% 2.96% 1.74% 2.50%

Variance 0.000122 7.55E-05 0.000122 0.000106

Observations 24 369 24 24

Pearson Correlation NA -0.1552

Hypothesized Mean Difference 0 0

df 25 23

t Stat -5.29 -2.28

P(T<=t) one-tail 8.87E-06 0.01608

t Critical one-tail 1.71 1.71

P(T<=t) two-tail 1.77E-05 0.032159

t Critical two-tail 2.06 2.07

0

10

20

30

40

50

0% 1% 2% 3% 4% 5% 6%

Num

ber

of

obse

rvati

ons

Cash as % of total assets

Distribution of observations

BBY BBN NBB

Cash levels prior to buyback announcements for BBY,BBN and

the same for NBB at the time of announcements by BBY, BBN

NBB has higher cash level

as compared with BBY in

the buyback years

BBN in the years without

buyback has higher cash

level as compared with

BBY in the buyback years

Comparing the sample distributions

Are the means of the

populations different?


Cash growth and Buybacks

Distribution

parameterBBY BBN NBB

Q1 -19.79% 8.54% 1.07%

Q3 68.26% 71.61% 59.03%

Mean 17.46% 32.98% 26.97%

Count 17 44 379

Unadj Skew 3.49 2.03 3.45

Unadj Kurtosis 14.17 5.92 21.56

Unadj Mn 33.80% 46.55% 42.57%

Skew 0.49 0.49 0.30

Kurtosis 1.25 -0.69 -1.11


BBY NBB BBY BBN

Mean 17.46% 26.97% 17.46% 34.14%

Variance 0.043075 0.029248 0.043075 0.031992


Pearson Correlation NA -0.20149


Df 17 16

t Stat -1.86 -2.29

P(T<=t) one-tail 0.040081 0.017914

t Critical one-tail 1.74* 1.75

P(T<=t) two-tail 0.080161 0.035827


0

10

20

30

40

50

0% 1% 2% 3% 4%

Num

ber

of

obse

rvati

ons

3 year CAGR of cash

Distribution of observations

NBB BBY BBN

Cash growth prior to buyback announcements by BBY,BBN and

over the same periods for NBB

Comparing the sample distributions



Neeladrinath Sarangi, HKU MBA* This test is single tailed and at 5% significance level, null hypothesis is rejected.

NBB has higher cash

growth as compared with


BBN in the years without

buyback has higher cash

growth as compared with


Excess cash and Buybacks


BBY NBB BBY BBN

Mean 6.55% 7.52% 6.55% 8.30%

Variance 0.002473 0.00111 0.0024732 0.0014199


Pearson Correlation NA 0.030465


Df 24 23

t Stat -0.95* -1.39*

P(T<=t) one-tail 0.17654 0.088174

t Critical one-tail 1.71 1.71

P(T<=t) two-tail 0.353079 0.176348


Excessiveness of cash measured in terms of current liabilities. Excess cash = Cash as a % of current liabilities. The primary motive for a firm to hold

cash is to meet its current liabilities and thus maintain adequate solvency.

Excess cash prior to buyback announcements for BBY,BBN and the same for NBB at the time of announcements by BBY, BBN




No statistically significant

difference in excess cash

levels between NBB and



difference in excess cash

levels between BBN in the

years without buyback and


* These tests are single tailed and at 5% significance level, null hypothesis are accepted for both.

Excess cash in NBBIs excess cash retained by NBBs for pursuing strategic investments such as acquisitions, expansions, restructuring and diversification?

Compare

• 3 year CAGR of cash just prior to a “jump” in investing cashflows of NBB firms in jump years

with

• 3 year CAGR of cash of NBB firms in years without jump.

“Jump”: 33% increase in investing cashflows in a fiscal year.

0

3

6

9

0% 20% 40% 60%

Num

ber

of

obse

rvati

ons

Distribution of 3yr cash CAGR prior to jump in NBB sample

Mean n

NBB (in years without jump) 22.54% 192

NBB (in years with jump) 31.09% 101

Standard deviation of NBB (without jump) 0.1544

Z score 0.5539



difference in 3 year CAGR

excess cash between NBB

firms in years with jump

and NBB firms in years

without jump

P ≈ 29% for computed Z score


equity?

Are buybacks a substitute for dividends?


Earnings and Dividend growth

If buybacks are capital distributions in place of dividends, there should be a change in earnings-dividend relationship after the

buybacks.

0

1

2

3

4

5

6

-70% -30% 10% 50% 90% 130% 170%

Num

ber

of

obse

rvati

ons

Dividend growth over 1FY / Net income growth over 1FY

Pre Buyback Post Buyback

Separate variance t test


Mean 33.72% 37.29%

Variance 0.1061506 0.3575202

Observations 29 31

Hypothesized Mean

Difference0

df 47

t Stat -0.29

P(T<=t) one-tail 0.386645

t Critical one-tail 1.68

P(T<=t) two-tail 0.773289

t Critical two-tail 2.01



difference in the ratio of

dividend growth to net

income growth in a BB

firm before buyback and

after buyback

Are the means of the populations different?


equity?

Are buybacks pursued to boost RoE and other return metrics?


RoE before and after Buybacks

0

1

2

3

4

5

6

7

8

-30% -21% -12% -3% 6% 15% 24% 33%

Num

ber

of

obse

rvati

ons

Change in ROE over 1FY




Mean -1.49% -5.88%

Variance 0.0244401 0.0155523

Observations 43 32

Hypothesized Mean

Difference0

df 73

t Stat 1.35

P(T<=t) one-tail 0.090361


P(T<=t) two-tail 0.180723





difference in the quantum

of change in RoE in a BB

firm before buyback and

after buyback


equity?

Are buybacks a means of signaling to the market and

influencing the stock price?


Price performance of stock being

repurchased

Analysis of excess returns in 22 buyback programs across industries, market

cycles and completion rates

Excess return = Daily return on stock being repurchased / Daily return on

comparable sectoral index on the same day

Excess return computed on days when shares were actually repurchased

during the lifetime of the buyback program

Volatility is computed as standard deviation



repurchased

Key metrics

Measurement intervals

ADER

VADER

AIDPV

1yr Pre

Post BR

BB period

BB days

1yr Post

Average daily excess return of stock having buyback program

Volatility of the average daily excess return of stock having buyback program

Average of the intraday price movement (high-low) as a % of the day’s low

The entire calendar year prior to the date of board resolution on the buyback

From the board resolution date till the date of commencement of the buyback

From the commencement of the buyback till its closure

On the days in the BB period when shares of the company were bought back in the NSE

The entire calendar year from the date of the closure of the buyback



repurchased

None of the selected 22 firms have issued or redeemed significant number of

shares (except via the buyback) in the 1yr Pre and 1yr Post period

If buybacks allowed firms to influence the share price, atleast for the

duration of the buyback,

ADER for BB period and especially on BB days should be higher than for 1yr Pre.

Further, VADER and AIDPV for BB period and BB days should be lower than for 1yr Pre.



repurchased

Groups Count Sum Average Variance

1yr Pre 22 -0.01519 -0.00069 2.82E-06

Post BR 22 -0.01198 -0.00054 5.48E-05

BB Period 22 0.003474 0.000158 5.83E-06

BB days 21 0.012383 0.00059 2E-05

1yr Post 19 0.003281 0.000173 3.77E-06

ADER : 1 factor ANOVA

Source of

VariationSS Df MS F P-value F crit

Between

Groups2.48E-05 4 6.21E-06 0.348161 0.844761 2.461698

Within

Groups0.0018 101 1.78E-05

Total 0.001825 105



difference in the excess

return of the stock before

the buyback, during the

buyback and after the

buyback




repurchased


1yr Pre 22 0.588934 0.026770 5.94562E-05

Post BR 22 0.582528 0.026479 0.000155699

BB Period 22 0.507383 0.023063 6.72996E-05

BB days 21 0.487227 0.023201 5.42118E-05

1yr Post 19 0.535391 0.028178 0.000178637

VADER : 1 factor ANOVA

Source of


Between

Groups0.000434 4 0.000109 1.07221304 0.374304 2.461698

Within

Groups0.010231 101 0.000101

Total 0.010666 105



difference in the volatility

of excess return of the

stock before the buyback,

during the buyback and

after the buyback




repurchased


1yr Pre 22 1.14558 0.052072 0.000208

Post BR 22 1.209345 0.05497 0.000326

BB Period 22 1.145743 0.052079 0.000438

BB days 21 1.062154 0.050579 0.000751

1yr Post 19 0.92275 0.048566 0.000109

AIDPV : 1 factor ANOVA

Source of


Between

Groups0.000454 4 0.000114 0.306544 0.873004 2.461698

Within

Groups0.037416 101 0.00037

Total 0.037871 105



difference in the intraday

price volatility of the

stock before the buyback,

during the buyback and

after the buyback




equity?

If buybacks are not about returning cash, dividend

substitution, return metrics, signaling to the market…etc,

what could they be about?



equity?

How about earnings volatility? And cashflow volatility?

Rather than being a substitute for dividends, could they

be complements?


Earnings and cashflow volatility Vs

Buybacks

Company managements typically avoid increasing or decreasing dividendssignificantly in a fiscal year to avoid surprising shareholders. Management ofshareholder expectations means just meeting their linear extrapolations ofearnings growth.

In this context, if a company experiences earnings volatility, distributing itthrough dividends is a challenge. Perhaps, some of these firms opt todistribute such volatile earnings by buybacks rather than dividends to avoiddrastically changing investor expectations on dividends. While specialdividends may allow for distribution of such excess earnings, it nonethelesstends to affect investor expectation, despite management’s highlighting theunique circumstances behind such special dividends.

Volatile earnings have two components: accrual and cash flow. Dividenddecisions are typically read from the net income angle by investors and hencetend to be accrual based.


Earnings and free cashflow volatility Vs

Buybacks

To test the distribution of volatile earnings hypothesis, the volatility of net

income and cashflows for firms which have pursued buybacks (and also pay

dividends) with firms which have not pursued buybacks (but pay dividends)

has been compared.

Volatility has been computed for each reporting year as the absolute

difference between that year’s net income or free cashflow as the case may

be with the average net income or free cashflow (as the case may be),

expressed as a % of the later


Earnings volatility

0

20

40

60

80

100

120

0% 80% 160% 240% 320% 400%

Num

ber

of

obse

rvati

ons

Net income volatility

BB firms NBB firms


BB Firms NBB firms

Mean 54.76% 89.83%

Variance 0.3790985 3.0421384

Observations 169 1053

Hypothesized Mean

Difference0

df 695

t Stat -4.90

P(T<=t) one-tail 6.08912E-07


P(T<=t) two-tail 1.21782E-06




Large, statistically

significant difference in

the volatility of net

income between BB firms

and NBB firms

NBB firms have higher

volatility of net income as

compared with BB firms

Free cashflow volatility


BB Firms NBB firms

Mean 2300.92% 485.45%

Variance 14672.423 787.41087

Observations 136 1053

Hypothesized Mean

Difference0

df 137

t Stat 1.74

P(T<=t) one-tail 0.04189035


P(T<=t) two-tail 0.0837807



0

50

100

150

200

250

300

0% 300% 600% 900% 1200%

Num

ber

of

obse

rvati

ons

FCF Volatility

BB firms NBB firms


Large, statistically

significant difference in

the volatility of free

cashflow between BB

firms and NBB firms

BB firms have higher

volatility of free cashflow

as compared with NBB

firms


equity?

Cash levels have little to do with share buyback decisions taken by firms

Share buybacks are distributions to shareholders over and above dividends

Buybacks have marginal to no significant effect on financial return metrics.

Financial return profile is likely to be inferior post buyback as against

reporting periods prior to the buybacks

Buybacks have no positive (adjusted) effects on the stock. There is no alpha

returns or reduction in risk. Shareholders and investors do not buy into

management’s signal about the undervaluation of the stock.



equity?

Firms opt to distribute earnings to shareholders via share buybacks when their

free cashflow is highly volatile and this volatility is poorly reflected in accrual

accounting based net income on which dividend decisions are read by

shareholders. Such firms have very little requirement to hold cash and

managements prefer to return such excess free cashflow to shareholders.

However not all such firms may use share buybacks to distribute abnormal

cashflows, with some managements using special dividends, increasing

dividends or accreting cash, anticipating future opportunities.


Thank you


why do listed companies buyback common equity? - some analysis from india

Economy & Finance

paidup class b

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