Name:- Tushar D Bane Std:- TYBCOM Div- C Roll no:- 374 Subject:- Financial Accounting Topic:-Buy Back of Equity

Shares Academic year:-2011-2012 Term:- 1St Term

Buy back of Equity shares

What is buyback?
Buyback is reverse of issue of shares by a company where it offers to take back its shares owned by the investors at a specified price; this offer can be binding or optional to the investors.

Why companies buyback? Unused Cash:

If they have huge cash reserves with not many new profitable projects to invest in and if the company thinks the market price of its share is undervalued. Eg. Bajaj Auto went on a massive buy back in 2000 and Reliance's recent buyback. However, companies in emerging markets like India have growth opportunities. Therefore applying this argument to these companies is not logical. This argument is valid for MNCs, which already have adequate R&D budget and presence across markets. Since their incremental growth potential limited, they can buyback shares as a reward for their shareholders.

Tax Gains
Since dividends are taxed at higher rate than capital gains companies prefer buyback to reward their investors instead of distributing cash dividends, as capital gains tax is generally lower. At present, short-term capital gains are taxed at 10% and long-term capital gains are not taxed.

Market perception
By buying their shares at a price higher than prevailing market price company signals that its share valuation should be higher. Eg: In October 1987 stock prices in US started crashing. Expecting further fall many companies like Citigroup, IBM et al have come out with buyback offers worth billions of dollars at prices higher than the prevailing rates thus stemming the fall.

Recently the prices of RIL and REL have not fallen, as expected, despite the spat between the promoters. This is mainly attributed to the buyback offer made at higher prices.

Exit option: If a company wants to exit a particular country or wants to close the company. Escape monitoring of accounts and legal controls
If a company wants to avoid the regulations of the market regulator by delisting. They avoid any public scrutiny of its books of accounts.

Show rosier financials :

Companies try to use buyback method to show better financial ratios. For eg. When a company uses its cash to buy stock, it reduces outstanding shares and also the assets on the balance sheet (because cash is an asset). Thus, return on assets (ROA) actually increases with reduction in assets, and return on equity (ROE) increases as there is less outstanding equity. If the company earnings are identical before and after the buyback earnings per share (EPS) and the P/E ratio would look better even though earnings did not improve. Since investors carefully scrutinize only EPS and P/E figures, an improvement could jump-start the stock. For this strategy to work in the long term, the stock should truly be undervalued.

Increase promoter's stake:

Some companies buyback stock to contain the dilution in promoter holding, EPS and reduction in prices arising out of the exercise of ESOPs issued to employees. Any such exercising leads to increase in outstanding shares and to drop in prices. This also gives scope to takeover bids as the share of promoters dilutes. Eg. Technology companies which have issued ESOPs during dot-com boom in 2000-01 have to buyback after

exercise of the same. However the logic of buying back stock to protect from hostile takeovers seem not logical. It may be noted that one of the risks of public listing is welcoming hostile takeovers. This is one method of market disciplining the management. Though this type of buyback is touted as protecting over-all interests of the shareholders, it is true only when management is considered as efficient and working in the interests of the shareholders. * Generally the intention is mix of any of the above * Sometimes Governments nationalize the companies by taking over it and then compensates the shareholders by buying back their shares at a predetermined price. Eg. Reserve Bank of India in 1949 by buying back the shares.

What are the methods in which buyback can happen?

Share buyback can take place in 3 ways: 1. Shareholders are presented with a tender offer where they have the option to submit a portion of or all of their shares within a certain time period and at usually a price higher than the current market value. Another variety of this is Dutch auction, in which companies state a range of prices at which it's willing to buy and accepts the bids. It buys at the lowest price at which it can buy the desired number of shares. 2. Through book-building process. 3. Companies can buy shares on the open market over a long-term period subject to various regulator guidelines like SEBI In both 1 & 2 promoters can participate in buyback and not in 3.

Restrictions on buyback by Indian companies:

Some of the features in government regulation for buyback of shares are: 1. A special resolution has to be passed in general meeting of the shareholders 2. Buyback should not exceed 25% of the total paid-up capital and free reserves 3. A declaration of solvency has to be filed with SEBI and Registrar Of Companies 4. The shares bought back should be extinguished and physically destroyed; 5. The company should not make any further issue of securities within 2 years, except bonus, conversion of warrants, etc. These restrictions were imposed to restrict the companies from using the stock markets as short term money provider apart from protecting interests of small investors.

Valuation of buyback:
There are two ways companies determine the buyback price. They use the average closing price (which is a weighted average for volume) for a period immediately before to the buyback announcement. Based on the trend and value a buyback price is decided In the 2nd, shareholders are invited to sell some or all of their shares within a set price range. The low point of the range is at a discount to the market price, while the top of the price range is set at a premium to the market price. Investors are given more say in the buyback price than in the above arrangement. Still this method is rarely used. Generally, the price is fixed at a mark up over and above the average price of the last 1218 months.

1.

PRELIMINARY STEPS
1.1 Check whether the Articles of Association (AoA) of the Company provides for buy-back of its own shares and if not , take steps to alter the AoA. [Section 77A(2) (a)]. 1.2 Determine the quantum of shares to be bought-back. This cannot exceed twenty-five percent of the paid-up capital and free reserves as per last audited Balance Sheet [section 77A(2) (c)].

1.3

Remember only fully paid up shares can be purchased [section 77A(2) (e)].

1.4

Ensure that the ratio of the debt owed by the company will be not more than twice the capital and its free reserves after such buyback. [Section 77(2) (d)].

1.5

Decide the quantum of the shares to be bought-back and the mode of purchase and the source of financing this purchase. Regulation 3(1) of SEBI (Buy Back) Regulations contemplates buy-back:(a) from the existing shareholders on a proportionate basis through tender offer, and

(b)

from open market through book building process, stock exchange, from odd lot holders. Though the regulations do not provide, sub-section (5) (d) of section 77A of CA clearly provides for the purchase of securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

1.6

Take steps to appoint Merchant Bankers, Registrars to the purchase, Bankers to the buy-back and prepare the necessary MOU setting out terms and conditions, scope of services and the responsibility and accountability thereof.

1.7

Check whether all public deposits, debentures and preference shares which are due and matured for payment together with accrued interest thereon are repaid in full and that no term loans from financial institution and bank is subsisting (section 77B ).

1.8

Decide the price to be offered in consultation with the MB.

2.

BOARD FUNCTIONS
2.1 Approve the quantum of shares to be purchased by the company and the price to be offered therefor.

2.2

Decide on the period upto which the offer should be kept open. This should be in conformity with Regulation 9(1).

2.3

Decide whether the shares are to be bought-back out of free reserves, securities premium account (though this term is not defined this should be taken to mean share premium account) or out of proceeds of earlier issue.

2.4

Arrange for financing of purchase, pass necessary resolution to borrow, if required.

2.5

Pass a resolution convening a general meeting to consider and adopt special resolutions for altering the AoA, if required and for the buy-back of its shares.

2.6

Approve the draft notice convening the general meeting containing the above special resolutions and the draft of the explanatory statement to be annexed thereto. The board must make sure that the special resolution is transparent and contains the necessary disclosures and that the explanatory statement contains the material facts as are required under Schedule-I of the Regulations and section 77A(3) of the Companies Act, 1956 (the Act).

2.7

Appoint or authorize MD or any one of the directors to appoint merchant bankers, registrars and bankers and settle the terms and conditions of such appointment and the scope of services of each one of them.

2.8

Authorize the MD or any of the directors of the company (i) to approve the offer document as and when submitted by the MB,

(ii)

to agree to such modifications or correction as may be suggested by SEBI or as may be necessary,

(iii)

to issue Public announcement as required under Regulation 8(1),

(iv)

to decide the details of acceptance of offers where the acceptances received are more than the offers made subject to this complying with the provisions of Regulation 9(4),

(v)

to execute such documents, papers, writings as may be required in the premises or as may be advised, and

(vi)

generally carry out all duties and functions as are required to effectuate the scheme.

2A.

General Meeting
(i) Pass special resolution to amend the AoA, if required, authorizing the company to purchase its own shares.

(ii)

Pass another special resolution to buy-back of shares as proposed and authorizing the Board to take all steps to buy-back its shares and also to approve the explanatory statement annexed to the notice convening the meeting as a token of acceptance of the disclosures.

3.
3.1

SECRETARIAL CHECK-LIST
Convene a Board meeting to transact the business as set out in para 2 above and any other business.

3.2

Convene a general meeting after giving due notice to transact the business as set out in para 3 above.

3.3

Inform Stock exchanges where the shares of the company as listed of the intention of the company to reduce its capital by buyingback its shares as required under the listing agreement.

3.4

File the Special resolutions with the Registrar of Companies within 30 days of passing of the said resolutions as required under section 192(4) (a) and or before making the purchases as required under sub-section (6) of section 77A of CA, whichever is earlier.

3.5

File the Special resolution for buy-back of shares with SEBI and SEs where the companies shares are listed within seven days of the date of passing of the said resolutions as required under regulation 5 (2).

Though the said regulation does not require the special resolution so filed to be accompanied by the explanatory statement it would be advisable as a good practice to file the explanatory statement as well, for, without this the desired purpose will not be served. 3.6 Ensure that the explanatory statement contains all the disclosures and information called for under Schedule-I of the regulations.

3.7

Ensure that no insider is dealing in securities of the company on the basis of unpublished information relating to buy-back [Reg. 4 (3) of the regulations].

3.8

Arrange for publication of Public announcement relating to buy-back in one English daily, one Hindi daily and one regional daily, which are widely circulating at the place where the Registered office of the company is, situate. [Reg. 8 (1)].

3.9

Ensure that the public announcement specifies a date which shall be the date for the purpose of determining the name of the shareholders to whom the letters of offer shall be sent. Since this is in the nature of a record date please make sure that this is fixed in consultation with the lead stock exchange after giving the requisite notice as required under the listing agreement [Reg. 8(2)].

3.10

Also ensure that the specified date is not earlier than thirty days and not later than 42 days from the date of public announcement [Reg. 8 (3)].

3.11

File draft letter of offer within seven days of the publication of the public announcement containing the disclosures specified in Schedule-III to the said regulations [Reg. 8 (4)] and that the filing fee as specified in Schedule-IV is paid simultaneously with filing of the letter of offer [Reg. 8(5)].

3.12

Ensure that the letter of offer are dispatched not earlier than twenty-one days from the submission to the Board [Reg. 8(6)].

3.13

File solvency certificate with SEBI and ROC in the manner and in the format prescribed by SEBI before commencing the purchase of the shares as required under sub-section (6) of section 77A of CA.

3.14

Make sure that the offer is kept open for a minimum period of fifteen days and not exceeding 30 days [Reg. 9 (1)].

3.15

The date of opening of the offer should not be earlier than seven days or later than 30 days after the Specified date (record date) [Reg. 9 (2)].

3.16

Complete verification of offers within fifteen days of closure [Reg. 9(5)].

3.17

Deposit escrow money before opening of offer for the amount specified under Regulation 10 (2).

3.18

Open a special bank account immediately after closure of the offer with a banker to the issue registered with SEBI and deposit therein such sum as would, together with the escrow account make up the entire sum due and payable for buy-back [11 (1)].

3.19

Monitor that payments to shareholders are made within seven days specified in sub-regulation (5) of regulation 9. The said regulation 9 (5) says that where the escrow account consists of bank guarantee, such bank guarantee shall be in favour of merchant banker and shall be valid for thirty days after closure [Reg. 11 (2)].

3.20

The company should extinguish and physically destroy the share certificates so bought-back in the presence of Registrars or merchant banker and the statutory auditor within seven days from the date of acceptance of the offer[Reg. 12 (1)]. If shares accepted or in dematerialized form these shall be extinguished and destroyed in the manner specified under Securities and Exchange Board of India (Depositories and Participants) regulations [Reg. 12 (2)].

3.21

The company should furnish a certificate to the board of SEBI duly verified by :(i) registrars or merchant bankers as the case may be,

(ii) (iii)

two whole-time directors including the MD, and the statutory auditors of the company certifying compliance within seven days of extinguishment or destruction of share certificates [Reg. 12 (3)].

3.22

The particulars of share certificates extinguished and destroyed shall be furnished to stock exchanges where the shares of the company are listed within seven days of extinguishment and destruction of the certificates [12 (4)].

3.23

The company shall maintain a record of share certificates, which have been cancelled and destroyed as prescribed in sub-section (9) of section 77A of CA [Reg. 12 (5)].

3.24

Take steps for the nomination of a compliance officer and investors service center for compliance with buy-back regulations and to redress grievances of the investors. [Reg. 19 (3)]. Company secretary is normally expected to discharge this function.

3.25

Shares which are locked-in and are not transferable at the time of acceptance cannot be bought-back [Reg. 19 (5)].

3.26

Ensure that within two days of compliance of buy-back, a public announcement is issued disclosing the number of shares bought, price at which they were bought, total amount deployed, details of shareholders from whom shares exceeding one per cent total shares bought-back and the consequential changes in the capital structure and the shareholding pattern after and before buy-back [Reg. 19(7)]

ABC LIMITED ACTIVITY CHART-BUY-BACK OF SHARES

ACTIVITY 1. Target Date

Consider in- principle approval of the Board to buy-back shares and X0 authorise two Directors, including the Managing Director and the Company Secretary to complete the formalities for the buy-back as per 2 below.

1.

PRELIMINARY STEPS

1.

Check whether the Buy-back is authorised by the Articles of Association (AoA) of the company: Yes, Article 27 A provides.

2.

Buy-back not to exceed twenty-five percent of the paid-up capital and free reserves as per last audited Balance Sheet provided that it shall not exceed twenty-five percent of its

total paid up equity capital in that financial year. 3. 4. 5. Only fully paid up shares can be purchased. Debt equity ratio shall not be more than 2:1. Decide the quantum of the shares to be bought-back and the mode of purchase and the source of financing this purchase. Rule 3 of Private Limited Company and Unlisted Public Company (Buy-Back of Securities) Regulations, 1998 contemplates buy-back:-

a)

from the existing shareholders on a proportionate basis through private offers, and

b)

form purchasing the shares issued to employees of the Company pursuant to Scheme of Stock Option or Sweat Equity.

6.

Check whether all public deposits, debentures and preference shares which are due and matured for payment together with accrued interest thereon are repaid in full and that no term loans from financial institution and bank is

2.

subsisting. The Directors and the Company Secretary to make an inquiry into X02 the affairs of the Company and to ensure that the Company does

3. 4.

5.

6.

have enough resources for the buy-back and for the purpose of declaration of solvency in Form 4A (Annexure-C) and draft letter of Offer containing the particulars as specified in Schedule-II to the Regulations. Refer Annexure-A for gist of Regulations. Follow-up with the Statutory Auditors of the Company to obtain a report as specified in Annexure-B Convene a Board Meeting:(i) To pass a resolution for buying back of shares (ii) To decide about the mode of the buy-back (iii) To approve the report of the Auditors (iv) To approve the Declaration of solvency in Form 4A verified by an affidavit signed by the Two Directors (Annexure-C) (v) To approve draft letter of offer (Annexure-D) (vi) To open a special Bank Account (vii) To approve the notice and explanatory statement for convening the Extra-ordinary General Meeting containing the particulars as specified in Schedule I to the Regulations in Annxure-A (For specimen special resolution and the explanatory statement see Annexure-E1 and E2) (viii) Constitute a Committee of MD and ED for the purpose of completing the formalities of buy-back Convene and hold the Extra-ordinary General Meeting :(i) To pass the special resolution for buy-back (ii) To authorise the Board to do all such acts, deeds and things necessary and incidental thereto File following documents with the ROC (i) Form 23 together with the notice and explanatory statement (ii) Form 4A (Annexure-C)

X12 X13

X40

X41

7. 8.

9. 10.

11.

12. 13. 14.

15.

(iii) Letter of Offer (Annexure-D) Despatch letter of offer to all the Shareholders. Deposit the entire amount due and payable as consideration, equal to the consideration to be payable on the shares proposed to be bought back in the special bank Account Offer to be open for minimum 15 days and maximum 30 days Complete the verification of the offers received by the cut-off date, if any offer is to be rejected return the share certificates to the shareholders Accept the offer from shareholders on proportionate basis if number of shares offered exceeds number of shares proposed to be boughtback. Make payment to those shareholders whom offer have been accepted Extinguish and physically destroy the share certificates so bought back in the presence of a Company Secretary in Whole time Practice File following documents with the ROC:(i) Return of Buy-Back of Shares in Form 4C (Annexure-F) (ii) A certificate signed by the two Directors and the Company Secretary in Whole time Practice by way of an affidavit that the Regulations prescribed by the Central Government has been duly complied with and the extinguishment and physical destruction of the share certificates have been done in their presence. (Annexure-G) Maintain a Register of Shares bought-back in Form 4B (see Annexure-H)

X42 X42

X62 X47

X47

X50 X51 X52

Regular basis

Examples of listed companies who have completed its Buy back program over the year:
Here we present a list of Ten companies that have, on average, beaten analysts earnings guidance estimates for the past four quarters (i.e. generated signficant earnings surprises). These companies have also recently announced stock buyback programs. When companies buy back their own stock, they use excess cash to reduce the number of shares outstanding, which directly increases earnings per share and (at least theoretically) adds value for shareholders. Some might even argue that management teams use buybacks to signal that their stock is undervalued List sorted by the average earnings surprise over the last year.

1. Teradyne Inc. (TER): Semiconductor Equipment & Materials Industry. Market cap of $3.33B. The company announced a buyback
program of $200M on 11/22/10, and has outperformed analyst earnings estimates by an average of 31.50% over the last year. The stock could be undervalued at current levels, with a PEG ratio at 0.67, and P/FCF ratio at 6.78. The stock has gained 68.96% over the last year.

2. Aetna Inc. (AET): Health Care Plans Industry. Market cap of $14.47B. The company announced a buyback program of $750M on
12/03/10, and has outperformed analyst earnings estimates by an average of 24.90% over the last year. AET may also be undervalued at current levels, with a PEG ratio at 0.86, and P/FCF ratio at 12.88. The stock has had a good month, gaining 13.13%.

3. Lattice Semiconductor Corporation (LSCC): Semiconductor Industry. Market cap of $797.78M. The company announced a
buyback program of $20M on 10/21/10, and has outperformed analyst earnings estimates by an average of 24.54% over the last year. The stock has gained 92.88% over the last year.

4. Unitrin Inc. (UTR): Property & Casualty Insurance Industry. Market cap of $1.79B. The company announced a buyback program of
$300M on 02/02/11, and has outperformed analyst earnings estimates by an average of 23.51% over the last year. The stock has gained 16.69% over the last year.

5. Corn Products International Inc. (CPO): Processed & Packaged Goods Industry. Market cap of $3.60B. The company announced a
buyback program of $5M on 11/17/10, and has outperformed analyst earnings estimates by an average of 23.11% over the last year. The stock has gained 37.77% over the last year.

6. PartnerRe Ltd. (PRE): Property & Casualty Insurance Industry. Market cap of $5.23B. The company announced a buyback program of
$7M on 12/30/10, and has outperformed analyst earnings estimates by an average of 22.47% over the last year. It has a relatively low correlation to the market (beta = 0.42), which may be appealing to risk-averse investors. The stock may also be undervalued, with a PEG ratio at 0.79, and P/FCF ratio at 5.05. The stock has gained 0.47% over the last year.

7. Cypress Semiconductor Corporation (CY): Semiconductor Industry. Market cap of $3.54B. The company announced a buyback
program of $600M on 10/21/10, and has outperformed analyst earnings estimates by an average of 21.59% over the last year. After a solid performance over the last year, CY has pulled back during recent sessions. The stock is 7.46% below its SMA20 and 2.52% below its SMA50, but remains 38.35% above its SMA200. The stock has gained 68.18% over the last year.

8. WD-40 Company (WDFC): Specialty Chemicals Industry. Market cap of $692.19M. The company announced a buyback program of
$25M on 12/14/10, and has outperformed analyst earnings estimates by an average of 20.07% over the last year. The stock has gained 27.84% over the last year.

9. Tiffany & Co. (TIF): Jewelry Stores Industry. Market cap of $7.96B. The company announced a buyback program of $400M on
01/20/11, and has outperformed analyst earnings estimates by an average of 19.54% over the last year. The stock has gained 39.56% over the last year.

10. Autodesk, Inc. (ADSK): Technical & System Software Industry. Market cap of $9.12B. The company announced a buyback program
of $20M on 12/14/10, and has outperformed analyst earnings estimates by an average of 19.00% over the last year. This is a risky stock that is significantly more volatile than the overall market (beta = 2.12). The stock has gained 38.74% over the last year.

Conclusion:
It may be remembered that buyback has no impact on the fundamentals of the economy or the company. Therefore investors should be cautious of unscrupulous promoters' traps.

Reference:www.google.com www.wikipedia.com www.msn.in