Why buybacks are not favoured by top Indian IT firms

SEBI made changes to the buyback norms, dividend distribution tax is up 20% making it inefficient

The top four IT services firms are sitting on a total cash pile of $15.5 billion as of  September 30, 2016 making several analyst believe that companies should look at the buyback programme to return cash to shareholders.

These companies are sitting on cash piles despite giving away regular dividends and in some cases investing a significant amount in acquisitions.  With the business model churning free cash, the situation would be similar across the sector.

According to a report by Kotak Institutional Equities, tier-I IT players pay out 40-50 per cent of net profits in the form of dividends and retain the balance cash for capex and acquisitions.

Buybacks have never been favoured by Indian corporates for several reasons but the current condition makes for a good case in favour of the same. One, the securities and exchange board of India (SEBI) made changes to the buyback norms, two the dividend distribution tax is up 20 per cent making dividend payout inefficient and three, there has been a sharp correction in the stock performance.

The report also goes on to say that a buyback programme will also have a positive impact on the earnings per shares (EPS) and return on equity (RoE).

But not all are convinced. Rajesh Gopinathan, CFO and VP, Tata Consultancy Services (TCS) feels that with regular dividend payouts buybacks do not look as attractive. Also, there are not enough examples of buybacks in the Indian context to draw reference. Earlier the perception was that you do buyback if your stock was hugely undervalued. It carried different market perception earlier. In US buyback is a normal mechanism of returns, he added.

Kawaljeet Saluja and Jaykumar Doshi of Kotak Institutional Equities also highlight that a share buyback assessment should look at EPS accretion and RoE kicker beyond the immediate fiscal year. Essentially, share buybacks are not about a one-time kicker but have a perpetual impact on EPS growth and RoE. They compare the buyback programmes that Accenture has carried.

Accenture's 15.3 per cent EPS CAGR over CY2003-16 was 370 bps higher than the company's (pre-minority) net income CAGR over the period. The impact on RoE emphasises the point even more: Accenture's (ex-minority) RoE in CY2016 would have been 13.6 per cent without the cumulative buybacks since 2003. The company's reported RoE for CY2016 was 63.5 per cent, said the report.

Traditionally, dividend distribution has been the best route to distribute surplus cash equally across all shareholders. With the higher tax impact on dividend distribution and further impact of tax in the hands of large shareholders, companies could explore buyback as an option to distribute the surplus cash. However, post the introduction of certain laws by SEBI to overcome the misuse of the buyback route being used by promoters to increase their stake and giving preferred exits to certain group of shareholders, buybacks have not been popular and some companies tend to reserve cash for inorganic growth.  
 

Further, the buybacks are not successful unless they are pegged at a good premium to the existing stock price, said Farid Kazani, MD Majesco and CFO Majesco (US).

His views are shared by the CFO of one of the top five IT firms, who on condition of anonymity said that if firms have not been able to use surplus cash as effectively they should look at returning the same to shareholders and buyback as a programme does look possible now. Last year TCS rewarded shareholders by giving out a special dividend to mark a decade of its listing. Also, at a time when growth has slowed, the tier-I players have been liberal with their payouts, he added.

Kazani agrees that buybacks do create positive impact to the EPS/ROE as it results into a lower share capital base, but he feels that the current stock correction is going to help. Although companies do find value in doing  buybacks at lower stock prices, the shareholders may be unwilling to surrender the shares. While IT companies do have surplus cash, they may consider reserving cash for acquisitions to supplement future revenue growth, he added.