Buybacks no panacea

IT majors should find better ways to use the cash

The decision of Tata Consultancy Services (TCS) to buy back its shares will be welcomed by a section of shareholders who can exit at a profit. At least two of TCS’ peers, Infosys and Wipro, have also hinted that a buyback decision could come in the near future. In general, as a tool to reward shareholders, buybacks seem to be gaining currency after last year’s additional tax on dividends above a threshold. But the record shows buybacks are not efficient in lifting share prices over the medium- and long-terms and can, at best, provide a short-term gain. For example, the top 10 buybacks in India show that shares gained an average of 1.5 per cent a year after the repurchases ended. Returns have been slightly better at eight per cent and six per cent, respectively, one year after the buyback’s announcement and commencement. In the case of the top 20 buybacks by size, average returns one year after their announcement, commencement, and end are 7.4 per cent, 8.5 per cent, and 4.3 per cent, respectively. 

Also, buybacks have a cost in the missed opportunities to invest in growth and innovation. A company that buys back its stock is often signalling to the market that it lacks profitable opportunities for investment. Share buybacks have played a role in established financial markets and their corporate performance monitoring structure. In the US, a chief executive officer (CEO)’s performance is judged extensively by how the stock behaves with the announcement of each quarterly result. One tool in the hands of a CEO, at least to buy some time with shareholders, is to humour them with a buyback using some of the accumulated reserves. 

Often, what drives the use of the buyback option is short-termism, led by institutional investors who have their own bottom lines to worry about. It is, therefore, not surprising that recently Cognizant, whose shareholder base is rooted in the US but whose development centres are hosted in India, also announced a buyback. It is also not difficult to see why TCS should go for it, considering that its recent financial results have trailed those of Infosys. 

A share buyback often signals subdued future expectations for an industry or a firm with a glorious past. If more Indian IT leaders go in for buybacks, it will underscore a widely perceived reality: Once a star, now ready for decline. Instead of buybacks, Indian IT majors will do well to use their cash to begin a transformative journey from a purely cost-arbitrage operation to creating radical IT technologies and intellectual property. The technology challenge for the sector is highlighted by Capgemini India CEO Srinivas Kandula, who has said that 60-65 per cent of the middle and senior level staff are not trainable. Nasscom has estimated that of the total Indian IT staff strength of 3.9 million, around 1.5 million need to be retrained. If middle and senior staff are beyond picking up new technologies then the focus will shift to freshers. However, the freshers, coming from mostly second-class engineering colleges, are of poor quality. Mr Kandula offers a significant explanation for this: The industry, driven by yield-seeking investors, has not invested enough in retraining in the past.