Tuesday, October 17, 2006

Buybacks...A little complicated

First Observation - Share Buybacks seem very simple at first glance
Second Observation - They are not !

What is a company offer to buyback its shares - A company buys back its own shares with cash and either cancels them or keeps them in treasury for re-issuing them later.

PS - In India Cancellation is a requirement as per law

Now I got interested in two share buybacks of sorts in the last week. I have not participated in either and have derived some investing wisdom out of the entire exercise.

Steps to be followed by me in the future -
a) Check the SEBI website for the buyback offer document
b) Read and reread the document and keep the number of shares outstanding and the number of shares to be bought back central to all calculations.
c) Check the market price of the share before the buyback was announced
d) Check the amount of money pledged to take care of the cash requirements because of the buyback offer

What happens is that the offer is normally for a certain share of the outstanding stock. An individual investor has to think about the acceptance ratio of shares which would be tendered to the company under the buyback offer.

The tradeoff to be calculated is that if the company buys back 25% of the total non promoter holdings of 50%, that means out of 100 shares that I buy, 50 will be bought back ( Working on a proportionate basis, which is the normal case ), Am I ready to be stuck with 50 shares of the company which will NOT be bought back.

This is the worst case scenario as there are approximately 20-30% shareholders who do not participate in the offer due to numerous reasons ( Brain Dead Investors )

One of the companies had a P/E ratio of 32 and a current market price which was more than 5 times book value. I was not comfortable holding 50 shares of this company especially when the fact that the market is at 13000 levels and there is a "supposed" bull run on is factored into the trade off equation.

One easy calculation is the break even price of the lot of shares that you would want to buy. This atleast gives you a clearer picture about what sort of price would have to be sustained in order for you to make a reasonable profit from the overall transaction.


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