Share buybacks by listed companies is a bad idea

General
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An Interesting article.

Few points which I did not understand

  1. Companies with debt on their balance sheets, especially those with a low debt-equity ratio, argue that increased leverage following a buyback would boost share price.

How does a low debt company after buyback using external borrowing which makes it a higher debt company boost share price? Increased borrowing would result in higher interest cost which might reduce profitability - How does share price increase in such a scenario.

Share price movement is purely based on demand and supply - so how can one say that share price could increase or decrease due to buy backs.

  1. Take a debt-free company. Assume the company has 50 thousand shares on its balance sheet and has earnings (profit) of $3 million. Therefore, the EPS is $60. Let’s assume that the surplus cash on the balance sheet is earning a return of 10%. If the company’s share price is $1000 and they announce a $12 million buyback programme at a price of $1,200 per share (a 20% premium over the prevailing market price), let’s see what happens to the EPS for the balance 40 thousand shares after the buyback. The amount the company spends on buyback is $12 million. This loss of cash from the balance sheet results in a reduction in earnings in the subsequent period of $1.2 million (the 10% that the surplus cash earned) and hence the EPS for the remaining 40 thousand shares drops from $60 to $45! So, imagine the plight of shareholders who chose not to tender their shares for sale in the buyback programme!

Query: In the above example, the buy back is at a premium of 20%. This means the existing shareholders who agreed to sell got the 20% premium, so what is the issue if the EPS falls after the buyback. They already got the premium of 20%. Saying cash balance would generate 10% - I do not think Corporates are interested in running a high cash balance (debt free corporates) and managing them. So is this a relevant example.

Another important point which the author missed, I think, is the Tax benefit on the share holder - Tax is paid by the company and not the shareholder in Buy Backs. This could be a disadvantage for shareholders who do not participate as the company is paying the taxes for the buyback for those who agreed to tender in the buyback.

All put together, not sure if the article is trying to portray the correct message that Buy back is a bad idea.

Yes Buy back could be a bad idea for investors who might not sell the shares during the offer period. The flaw I find is when the Buy Back is announced, lot of new investors buy just to avail the benefit. This might be not good for existing shareholders who been holding the shares for long.

@Akash_Shah

2

Sometime doing too much analysis is also not useful :slight_smile:
This is one of those scenarios.

Without going into too much details, Buyback is just a way of giving cash back to shareholder. Nothing else.
Think of it as an optional dividend. It is offered to all shareholders. If someone still decides that they don’t want it, then they should not be complaining that they have been short-charged.

No lower debt company after buyback does not become high debt company. It still remains low debt company
Company is not taking on debt to do buyback (that isn’t even allowed in India). But they are using available cash to do buyback. So interest cost does not increases (but other income does reduce)

In short term yes, it is demand supply, but in long term it is always fundamentals.
And for a good cash generating business, fundamental does improve.

One of the major reason is spare cash with company typically earns less return (most of it is invested in short term instrument earning 6-7%) than company business which could be 15-20% or more.
So when there is lot of spare cash o company balance sheet blended return comes down making company less attractive for investors.

Nobody stops them from selling in buyback and buying shares back from market.

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