ROLL NO.

392

VIVEK COLLEGE OF COMMERCE

NAME: - ANKIT JAIN ROLL NO. 392 STD & DIV: - T.Y. B.COM. |C} SUBJECT: - ACCOUNTS

TOPIC: - BUY BACK TERM: - 1 TERM

ST

ACADEMIC YEAR: - 2011 -12

VIVEK COLLEGE OF COMMERCE

ROLL NO. 392

INDEX 1. INTRODUCTION. 2. MEANING. 3. HISTORY. 4. OBJECT OF BUY BACK. 5. REASONS FOR BUY BACK. 6. WHAT ARE THE METHODS IN WHICH BUY BACK CAN BE DONE. 7. RESTRICTIONS ON BUYBACK BY INDIAN COMPANIES. 8. CONDITIONS FOR BUY BACK 9. EFFECT OF BUY BACK ON STOCK MARKET

VIVEK COLLEGE OF COMMERCE

ROLL NO. 392

INTRODUCTION
Share capital is a very essential part of a company, listed or unlisted. Share capital can be of two types i.e. equity share capital or preferential share capital. The share capital of a company has to be subscribed by one or more persons. After the share of a company has been allotted to the subscribing members, the subscribers have no right over the money gone as proceeds of the shares subscribed. All that the shareholder has is the right to vote at the general meetings of the company or the right to receive dividends or right to such other benefits which may have been prescribed. The only option left with the shareholder in order to realize the price of the share is to transfer the share to some other person. But there are certain provisions in the companies act which allow the shareholders to sell their shares directly to the company and such provisions are termed as buy back of shares. Buy back of shares can be understood as the process by which a company buys its share back from its shareholder or a resort a shareholder can take in order to sell the share back to the company.

VIVEK COLLEGE OF COMMERCE

ROLL NO. 392

WHAT DOES BUYBACK MEAN?

The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies will buy back shares either to increase the value of shares still available (reducing supply), or to eliminate any threats by shareholders who may be looking for a controlling stake

HISTORY
Prior to the amendment of the 1999 of the companies act there was no way a company could buy its shares back from the shareholders without a prior sanction of the court (except for the preferential shares). The laws as to the buying of its share by the companies were very stringent. Some of the ways by which a company could buy its shares back were as follows:(i) Reduction of share capital as given in sections 100 to 104. (ii) Redemption of redeemable preferential shares under section 80. (iii) Purchase of shares under an order of the court for scheme of arrangement under section 391 in compliance with the provisions of sections 100 to 104. (iv) Purchase of shares of minority shareholders under the order of the company law board under section 402(b). Though there were ways by which a company could buy its shares back from the shareholders but it could not be done without the sanction of the court. This was done to protect the rights of the creditors as well as the shareholders. But the need of less complex ways of buying its shares back by the company was always felt. The much needed change in the companies act was brought about by the companys amendment act 1999.Sections 77A; 77AA and 77B were inserted in the companies act by this amendment.

OBJECTIVES OF BUY BACK:

Shares may be bought back by the company on account of one or more of the following reasons i. To increase promoters holding ii. Increase earnings per share iii. Rationalise the capital structure by writing off capital not represented by available assets. iv. Support share value v. To thwart takeover bid VI. To pay surplus cash not required by business Infact the best strategy to maintain the share price in a bear run is to buy back the shares from the open market at a premium over the prevailing market price.

VIVEK COLLEGE OF COMMERCE

ROLL NO. 392

REASONS FOR BUY BACK

In the words of the working group which recommended the introduction of buy back in the companies act: It is an erroneous belief that the sole reason for buy back is to block hostile take-over. In this connection it is pertinent to list five reasons why the bank of England favoured the making of law to allow companies to repurchase their shares of which blocking take-over was only one: (i) To return surplus cash to shareholders (ii) To increase the underlying share value (iii) To support the share prices during temporary weakness. (iv) To achieve or maintain a target capital structure. (v) To prevent or inhibit unwelcome take-over bids. Briefly a company resorting to the buyback may have surplus cash, and it may not have found the right avenue to invest such surplus cash, during such period of dilemma the company may decide to return the surplus cash by buying back its shares, with a hope that at a later time when the company brings on an expansion the investors do not lose their faith in the company. Secondly the company might as well think of buying its shares with a view to increase the value of the shares which after the process of buy back still remain in the market. For after the shares are bought back the number of marketable shares become less and thus the prices increase. Thirdly, at times there is a slump in the share market due to no fault of the company. Though the slouch may be temporary but may have continued far too long .The management then may decide to give value to the shareholders and buy back their shares at a price higher than the market price. This is generally done to instill faith in the minds of the shareholders. Saving a company from hostile take-over has always been seen as a major force behind bringing about this amendment, the company may use the surplus cash available in buying back its shares and bringing the number of floating shares down, resulting in the suitor not finding it a worthy investment or a profitable acquisition. These could be certain reasons why a company may resort to buy back of its shares.

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. Egg. 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 buy back shares as a reward for their shareholders.

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ROLL NO. 392

* 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. E.g.: 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 e.g. 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 companys 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. E.g. Technology companies which have issued ESOPs during dot-com boom in 2000-01 have to buyback after

VIVEK COLLEGE OF COMMERCE

ROLL NO. 392

exercise of the same. However the logic of buying back stock to protect from hostile takeovers seems 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. E.g.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 regulatory 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.

VIVEK COLLEGE OF COMMERCE

ROLL NO. 392

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 12-18 months.

ANY MANIPULATIONS?
Some companies come out with a scheme of buyback wherein, unless the shareholders rejected the offer specifically, in response to the offer letter sent by the company, they would be deemed to have accepted it. Though courts have upheld the action of the companies, it is to be noted that small shareholders generally do not bother to read such letters and respond to the same, and may not understand the complex legal language used in such letters. Some companies make it compulsory for shareholders to sell at a specified price mandated by the company. A shareholder enters a company by choice and mutual agreement and should be entitled to exit only by choice. Forcible buyback of shares at a non-transparent price would be expropriation and should be prevented. Note: Goos budget of FY 2002-03 has relaxed buyback rules for the companies by which buyback of shares up to 10% of paid-up capital does not require shareholders approval thus putting the minority shareholders at the mercy of majority shareholders and promoters. E.g. MNCs listed on exchanges have taken this route in a big way in 2001-2003

VIVEK COLLEGE OF COMMERCE

ROLL NO. 392

CHECKLIST FOR INVESTORS BEFORE ACCEPTING THE COMPANY'S BUYBACK OFFER:

* Take a look at the share price movement immediately before the buyback. If there was a significant rise, the prima facie assumption is that the promoters have been up to tricks. * Debt-equity ratio: The companies Aare hugely under debts are unlikely to have free cash * Companies that have just come to the capital markets to raise money are unlikely to be good candidates for buyback. * When the management has passed special resolutions, with a lot of publicity, empowering the Board to buy back whenever allowed, there is enough scope for suspicion. Anybody with the genuine intention of buying back to enhance shareholders' wealth would try to do so with minimum publicity so that the share price does not flare up due to speculators.

EFFECT OF BUYBACKS ON STOCK EXCHANGES:

Buyback may leads to abnormal increase of prices posing heavy risk to those who value shares based on fundamentals. This may also lead to reduction in investor interest in the market particularly with de-listing of good shares. E.g.: It was feared in 2001-03 that de-listing by many MNCs may drop the money flow to stock exchanges.

RESOURCES OF BUY BACK:

The companys amendment act 1999 under section 77A prescribes for the sources of buying back of shares or other specified securities by a company, which are as follows-: i) Free reserves- a company may buy back out of its free reserves but a sum equal to the nominal value of the shares so purchased must be deposited in the capital redemption reserves account. ii) Securities premium account. iii) The proceeds of any shares or specified securities. No buy back of any shares or securities shall be made out of the proceeds of an earlier issue of the same kind of shares of same kind of securities

VIVEK COLLEGE OF COMMERCE

ROLL NO. 392 CONDITIONS OF BUY BACK

(a) The buy-back is authorised by the Articles of association of the Company;

(b) A special resolution has been passed in the general meeting of the company authorising the buy-back. In the case of a listed company, this approval is required by means of a postal ballot. Also, the shares for buy back should be free from lock in period/non transferability. The buyback can be made by a Board resolution if the quantity of buyback is or less than ten percent of the paid up capital and free reserves; (c) The buy-back is of less than twenty-five per cent of the total paid-up capital and fee reserves of the company and that the buy-back of equity shares in any financial year shall not exceed twenty-five per cent of its total paid-up equity capital in that financial year; (d) The ratio of the debt owed by the company is not more than twice the capital and its free reserves after such buy-back; (e) There has been no default in any of the following i. in repayment of deposit or interest payable thereon, ii. Redemption of debentures, or preference shares or iii. Payment of dividend, if declared, to all shareholders within the stipulated time of 30 days from the date of declaration of dividend or IV. Repayment of any term loan or interest payable thereon to any financial institution or bank; (f) There has been no default in complying with the provisions of filing of Annual Return, Payment of Dividend, and form and contents of Annual Accounts; (g) All the shares or other specified securities for buy-back are fully paid-up; (h) The buy-back of the shares or other specified securities listed on any recognised stock exchange shall be in accordance with the regulations made by the Securities and Exchange Board of India in this behalf; and (i) The buy-back in respect of shares or other specified securities of private and closely held companies is in accordance with the guidelines as may be prescribed.

MODES OF BUY BACK:

Buy back of shares or other specified securities can be done through various sources which have been illustrated under sub section 5 of section 77A, they are as follows:a) From the existing security holders on a proportionate basis or b) From the open market, through; i) Stock market ii) Book building process c) From odd lots, that is to say where the lot of securities of a public company, whose Shares are listed on a recognised stock exchange, is smaller than such marketable Lot, as may be specified by the stock exchange; d) By purchasing the securities issued to employees of the company under a scheme Of stock option or sweat equity.

VIVEK COLLEGE OF COMMERCE

ROLL NO. 392

DISCLOSURE IN THE EXPLANATORY STATEMENT:

Notice of the meeting at which a resolution for buy back is proposed to be passed has to be accompanied by an explanatory statement stating a) A full and complete disclosure of all material facts b) The necessity for buy back c) Class of securities intended to be bought back under the buy back d) The amount to be invested under buys back.

SOURCES FROM WHERE THE SHARES WILL BE PURCHASED

The securities can be bought back from (a) existing security-holders on a proportionate basis; Buyback of shares may be made by a tender offer through a letter of offer from the holders of shares of the company or (b) the open market through (i). book building process; (ii) stock exchanges or (c) odd lots, that is to say, where the lot of securities of a public company, whose shares are listed on a recognized stock exchange, is smaller than such marketable lot, as may be specified by the stock exchange; or (d) purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

FILING OF DECLARATION OF SOLVENCY

after the passing of resolution but before making buy-back, file with the Registrar and the Securities and Exchange Board of India a declaration of solvency in form 4A. The declaration must be verified by an affidavit to the effect that the Board has made a full inquiry into the affairs of the company as a result of which they have formed an opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year of the date of declaration adopted by the Board, and signed by at least two directors of the company, one of whom shall be the managing director, if any: No declaration of solvency shall be filed with the Securities and Exchange Board of India by a company whose shares are not listed on any recognized stock exchange.

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ROLL NO. 392

REGISTER OF SECURITIES BOUGHT BACK:

Section 77A (9) prescribes for the manner in which a register shall be maintained a register of shares so bought back and enter therein the following particulars:i) The consideration paid for the securities bought back. ii) The date of cancellation of securities iii) The date of extinguishing and physically destroying of securities. iv) Other particulars as may be prescribed. The shares or the securities so bought back shall be physically destroyed within seven days from the last date f completion of such buy back.

ISSUE OF FURTHER SHARES AFTER BUY BACK

every buy-back shall be completed within twelve months from the date of passing the special resolution or Board resolution as the case may be. A company which has bought back any security cannot make any issue of the same kind of securities in any manner whether by way of public issue, rights issue up to six months from the date of completion of buy back.

FILING OF RETURN WITH THE REGULATOR

A Company shall, after the completion of the buy-back file with the Registrar and the Securities and Exchange Board of India, a return in form 4 C containing such particulars relating to the buy-back within thirty days of such completion. No return shall be filed with the Securities and Exchange Board of India by an unlisted company.

PROHIBITION ON FURTHER ISSUE OF SHARES AFTER BUY BACK:

Every buy back shall be completed within twelve months from the date of passing the special resolution or the board resolution as the case may be. After the buy back is completed the company is not allowed to issue the bought back shares for the period of six months by any means including further issue of shares under section 81(1)(a) of the companies act 1956. It may however issue bonus shares or discharge its subsisting obligation of converting preference shares or other specified securities into equity shares.

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ROLL NO. 392

PROHIBITION OF BUY BACK IN CERTAIN CIRCUMSTANCES:

Section 77B holds the restrictions on the companies to buy back its shares. No company shall buy its own shares or other specified securities a) Through any subsidiary company including its own subsidiary company.

DECLARATION OF SOLVENCY:
Where a company has passed a special resolution under clause b of sub-section (2) or a board resolution has been passed under some circumstances to buy back its own shares or other specified securities, under the section, it shall before making such buy back ,file with the registrar and the securities and exchange board of India a declaration of solvency in the form as may be prescribed and verified by an affidavit to the effect that the board has made a full enquiry into the affairs of the company as a result of which they have formed an opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a period one year of the date of declaration adopted by the board, and signed by at least two directors of the company, one of whom shall be the managing director, if any

PROCEDURE FOR BUY BACK

a. Where a company proposes to buy back its shares, it shall, after passing of the special/Board resolution make a public announcement at least one English National Daily, one Hindi National daily and Regional Language Daily at the place where the registered office of the company is situated. b. The public announcement shall specify a date, which shall be "specified date" for the purpose of determining the names of shareholders to whom the letter of offer has to be sent. c. A public notice shall be given containing disclosures as specified in Schedule I of the SEBI regulations. d. A draft letter of offer shall be filed with SEBI through a merchant Banker. The letter of offer shall then be dispatched to the members of the company. e. A copy of the Board resolution authorising the buyback shall be filed with the SEBI and stock exchanges. f. The date of opening of the offer shall not be earlier than seven days or later than 30 days after the specified date. g. The buyback offer shall remain open for a period of not less than 15 days and not more than 30 days. h. A company opting for buy back through the public offer or tender offer shall open an escrow Account...

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PENALTY
if a company makes default in complying with the provisions the company or any officer of the company who is in default shall be punishable with imprisonment for a term which may extend to two years, or with fine which may extend to fifty thousand rupees, or with both. The offences are, of course compoundable under Section 621A of the Companies Act, 1956.

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.

VIVEK COLLEGE OF COMMERCE