Bajaj Auto's share buyback: What is a stock buyback, how does it work and should you tender your shares?

On June 27, 2022, the board of directors of Bajaj Auto Limited approved the proposal for the buyback of the company's shares at ₹4,600 per share, over a premium of 20.67% or ₹787.2 higher than Friday's closing price of ₹3,812.00. The board also made it clear that Bajaj Auto's share buyback won't exceed ₹2500 crore.

As per the approval, the company has cleared the proposal for the buyback of the fully paid-up equity shares with a face value of ₹10 each from existing shareholders.

The buyback programme will not include the promoters and promoter group of the company.

The buyback will be carried out at a price not exceeding ₹4,600 per equity share and for an aggregate amount of up to ₹2,500 crore. This represents 9.61 per cent and 8.71 per cent of the aggregate of the total paid-up share capital and free reserves (including securities premium account), Bajaj Auto said in a regulatory filing.

The maximum number of equity shares proposed to be bought back would be 54,34,782 equity shares ("Proposed Buyback Shares"), comprising approximately 1.88 per cent of the paid-up share capital of the Company as of June 27, 2022.

The company last went for such a move in 2000, when shareholders approved the buyback of up to 18 million equity shares at a price of ₹400 each.

Further, enterprise communications service provider Route Mobile board approved the buyback of shares in the open market, the company said in its filing with the exchanges.

At the maximum buyback price ( ₹1,700) and maximum buyback size ( ₹120 crore), the indicative maximum number of equity shares bought back would be 705,882, or 1.12% of the total number of paid-up equity shares of the company.

Let's look at what is a stock buyback and how does it work

What is a stock buyback?

A stock buyback, or share repurchase, is when a company repurchases its own stock. Companies typically purchase shares at a premium to the market price. Following the buyback, the total number of outstanding shares will get reduced, as repurchased shares were absorbed by the company. A buyback usually results in an increase in share price due to demand and supply mismatches that emerge when there are fewer shares available in the market for trade.

Furthermore, the need for a buyback arises when management considers that the shares are undervalued or if the outstanding shares are falling. 

The buy-back of shares is governed by Section 68 of the Companies Act, 2013.

Companies can repurchase shares in two ways: on the open market or through a tender request.

Tender Offer: In this process, the company sends out a tender form to its shareholders asking them to sell their shares. The offer has the complete details of the buyback.  The tender offer will include a price range, and interested investors can name their price within that range. The company will purchase the shares at the lowest cost.

Open Market: In this way, a company buys the shares directly from the secondary market. In this case, the purchase is completed at the market price.

Reasons for buyback of shares

One of the primary reasons for a company to do a share repurchase is to reduce the number of shares on the market. This will eventually increase the demand for the stock. When there are fewer outstanding shares available for trade, each share is worth more, so the prices go up.

On the other hand, if the buyback seems not to be in the best interest of the company, the shares could increase less than the reduction in shares would indicate, or could even decrease over the short term.

The other reason was that buybacks are the most tax-effective means of rewarding shareholders. Unlike dividends, there is no three-level tax on buybacks. So it is a better and tax-effective way for the company to reward the shareholders.

However, the buyback tax was introduced on unlisted companies in 2013 and extended to listed companies in July 2019. Both listed and unlisted companies have to pay the tax at 20% plus a surcharge of 12% and a health and education cess of 4%, aggregating to 23.30% of the ‘distributed income’, according to media reports.

Currently, shareholders don't have to pay any taxes on buyback income through the tender route but have to pay capital gains tax were applicable if the buyback happens through the open market.

Another reason is that the company might pursue a buyback to improve its financial ratios—the metrics used by investors to analyse a company's value. Repurchase of stock reduces the amount of cash on a company's balance sheet, which improves the Return on Assets Ratio. And Return on Equity ratio will increase because there is less outstanding equity. 

Further, if the number of outstanding shares is reduced, it increases the company's earnings per share (EPS), and when EPS is increased, it reduces the price to earnings multiple.

For example, if ABC firm earned ₹1,00,000 in the quarter preceding the share buyback and has 10,00,000 shares outstanding, their EPS is ₹0.10. The corporation has recently announced a share buyback of 500,000. Assume earnings remain constant at 1,00,000, but EPS climbs to ₹0.20 due to the fact that there are now only 5,00,000 shares outstanding after the buyback.

Stock buybacks of 2021-2022

Here are some of the recent stock buybacks announced in 2021-2022.

Is a Stock buyback Good for Investors?

In most circumstances, a stock buyback is a good news for those who already hold the stock. First, it usually means that the company has lots of cash, which is a good position for a company to be in. Secondly, a buyback will usually increase the stock’s price, so an investor’s position in the stock will be worth more money.

However, if a company borrows money to fund the buyback of shares, this can make a company less attractive to investors. A debt-based share buyback can negatively impact a company’s cash flow. And if a company is borrowing to finance a buyback, it may mean that it needs to improve its financial ratios and is using a buyback to do that.

Warren Buffett’s views on stock buybacks

Legendary investor Warren Buffett has commented frequently on the merits of share repurchases over the years and has called their disciplined use the surest way for a company to use its cash intelligently.

In his 2011 letter to Berkshire Hathaway shareholders, he identified the two conditions that must be met in order for him to favor a company buying back its own shares.

1. The company must have enough money to handle the operational and liquidity needs of the business.

2. The company’s shares must be selling at a significant discount to a conservative estimate of their intrinsic business value.