The information technology (IT) sector has seen a spate of buyback offers and rumours. Infosys, Tata Consultancy Services (TCS), HCL Technologies, Wipro and Cognizant (not listed in India) have all made buybacks or considered doing so. Outside IT, major public sector units (PSUs) like Oil India (OIL), NMDC, MOIL and Coal India (CIL) have also done buybacks. So have some cash-rich multinational corporations (MNCs) like Novartis India and Bosch. Each of these cases had, or will have, individual pros and cons. The investor will have to study the specific cases in detail to decide whether he or she wishes to either offer existing shareholdings or to arbitrage the situations by buying the shares in question to make an offer. But, the trend is unusual and worth a comment. Share buybacks are one of several ways in which companies can try to reward shareholders. The company liquidates some portion of its reserves and allows shareholders to cash out their positions if they wish. By extinguishing shares, the company also reduces the equity base and reserves, which means earnings per share and return on net worth rise due to the smaller-base effect. Quite often, a reduction of the number of shares also leads to a higher share price, even after the buyback is completed. So, a buyback can also contribute to price support. The debt-equity ratio cannot exceed 2:1 after the buyback. So, a high-debt company with a stressed balance sheet cannot easily do this. On the downside, a buyback is an admission by the management that there is no superior investment visible. Hence, these are usually done by mature businesses, which possess a fair amount of cash on the books but not too much in the way of future growth prospects. A buyback can be a tax-efficient process. The 2016-17 Union Budget made buybacks more efficient than dividend payouts, for large shareholders at least. As things stand now, a dividend payout attracts 20.9 per cent dividend distribution tax, payable by the company. It is taxed again, at 11.9 per cent, if the dividend is received by a large shareholder who receives Rs 10 lakh or more in dividend. A share buyback is treated as long-term capital gains if the shareholder has owned the stock for over 12 months (this assumes the buyback is done via the stock exchanges and Security Transaction Tax is paid).
Hence, a long-term shareholder who takes a buyback offer pays zero tax. A short-term shareholder pays a tax rate of 15 per cent in short-term capital gains. The company obviously pays no tax.Buyback and dividend payout decisions are made by management, usually controlled by long-term shareholders with significant equity stakes. Since the buyback is clearly more efficient for them, there is a tilt towards this. For an arbitrageur, there are tax considerations and proportionate ratio to consider. The prevailing price and short-term capital gains tax rate are known, and so is the buyback offer price. Thus, it is possible to work out if the deal is profitable enough to buy shares off the market. It is quite likely a tempting offer price will lead to a lot of shares being offered and the market price of the share rising. In that case, there will be a proportionate ratio of buybacks accepted and the arbitrageur could be left holding some sort of a residual stake. When it comes to PSUs, the buyback offers have mainly come about because the majority shareholder is looking to milk cash off reserves. A cash-rich PSU can efficiently transfer cash to the government through a buyback offer. It is better, or more transparent at any rate, than the earlier system of creating cross-holdings where PSU A used reserves to buy shares of PSU Y, which used its reserves in turns to buy shares of PSU X. The spate of buybacks in the IT sector is a clear signal of the stagnation and apprehension in the sector. Most IT majors have substantial cash piles. There is obviously low visibility of growth prospects if these companies are prepared to hand that cash back to shareholders rather than explore investment options. Prospects in the US are questionable due to the possibility of a tightening H1B visa regime and also threats of a tax on outsourcing. Brexit will hit European operations hard as well. But, it seems IT companies are also not seeing much in the way of investment opportunities in domestic initiatives like Digital India and Smart Cities.