ONLY listed companies with excess cash should conduct share buybacks. Likewise, the exercise should only be undertaken on condition the market is substantially undervaluing the shares.
Such is the opinion of Minority Shareholders Watch Group CEO Devanesan Evanson who further cautioned that share buybacks done to support the share price is tantamount to manipulation.
On that note, investors must be wary that share buybacks are not used as an exit mechanism for some ‘connected’ shareholders to exit at an attractive price.
“MSWG does not encourage listed companies to borrow money to undertake share buy backs or use cash that has been earmarked for some other business purpose such as business expansion or fixed asset investments,” he told FocusM.
Devanesan was commenting on a recent Bloomberg report citing Credit Suisse which revealed that Malaysian companies have bought back shares worth RM590 mil this year, the biggest annual amount ever.
The report based on a research note by analyst Danny Goh noted that the value of buybacks jumped by 409% compared with the full period of last year.
“This year’s buybacks are led by firms including Top Glove (Corp Bhd), Genting Malaysia (Bhd) and Yinson (Holdings Bhd); Credit Suisse has outperform ratings on all three,” added the report.
Ample cash is necessary
According to Devanesan, share buyback is healthy if it is done with excess cash and for the right purpose, notably the share prices are deemed undervalued by the market, and the end-intention is to enhance shareholder value either through increased earnings per share (EPS), sell back to the market at a profit or distributed to shareholders as dividend-in-specie.
Theoretically, share buy backs reduce the number of shares available in the market and as such the EPS will go up. All things being equal, the increased EPS should translate into a share-price increase which is good for the shareholders.
“Nevertheless, some shareholders prefer the company’s excess cash to be given as dividends rather than it being used for share buybacks,” suggested Devanesan.
“But dividends result in a cash outflow from the listed entity; if the buyback shares are resold in the market, the cash comes back to the company”.
To sum up, below are the pros and cons of a share buyback exercise:
Pros
- It increases EPS, hence share prices. The EPS rises as there will be a lower float of shares. If the shares are later sold at a profit, the company benefits.
- Buybacks also shows confidence in the price of the shares as the listed company is of the opinion that the shares are cheap enough to buyback. This gives confidence to other shareholders.
- The shares that are bought back may be distributed as dividend-in-specie to shareholders.
Cons
- To support the share price, perhaps to avoid a margin call. Supporting share price in this way is tantamount to manipulation.
- Share buybacks tend to increase the share price and this may be done to give an opportunity for ‘connected’ persons to exit at a higher price.
- Money that is earmarked for business is used for the buyback and as a result there is not enough money to conduct business.
- Sometimes, the shares bought back fall to lower prices and never recover, resulting in a loss in the cash invested in buybacks; it would then be better to just utilise the cash as dividends. – Nov 3, 2020
