Do share buybacks lead to value creation? Not always

MUMBAI: Recently, some influential shareholders of Infosys, including former chief financial officers TV Mohandas Pai and V Balakrishnan, wrote to the company’s board to immediately consider a buyback of shares on the ground that there is a valuation disconnect between it and peers.

In theory, it made a lot of sense for companies to utilise idle cash for this purpose. But do share buybacks always create value?

A study of the performance of shares of companies, which have done buybacks after 2013, belies this theory. Out of the 36 share buybacks since 2013, shares of 21 companies including Cairn, Bayer CropScience, Jindal Steel & Power and HT Media have underperformed the Sensex. Some of them announced the buyback when the stocks were near their peak.

When a company buys back shares, the reduction in outstanding shares boosts ratios such as earnings per share, which should theoretically lift share prices.

But, in many cases, the market seems to have punished the company for its wrong pricing and timing. Not only did the share price suffered, the enterprise value (EV) — the price of the firm — contracted too.

For instance, JBF Industries had announced a buyback of shares at a premium of about 25% of the share price then.

However, within a month of the buyback announcement, the shares underperformed the Sensex by 3.6%. Over the next six months, JBF shareholders lost 20% of their investment value while Sensex gained 13% during the same period. The company seemed to have offered the buyback at a time when its price to earnings multiple was 5.55 times as against its 3-year average of 3.4 times.

Success or failure of any buyback depends largely on getting the choice of investment timing right, said analysts. “The reality is not all buybacks are destined to be successful. Buybacks make sense and help create value only when the timing is right and the stock is undervalued,” said Aman Chowdhury, co-CEO, Cians Analytics.

Sinclairs Hotels announced buyback at 25% premium to prevailing market price. The stock lost 7.4% in the first month post the announcement and reported an adjusted return to the Sensex of a negative 45% over the 6-month period.

Similarly, Cairn India lost 14% relatively over a 6-month period after the buyback was announced.

Claris Lifescience lost 44%, Bayer CropScience (-17%), Jindal Steel & Power (-17) and HT Media (-22.2%). “Companies buy back shares only when they fail to create value to shareholders,” said Chokkalingam G, founder and CEO, Equinomics Research & Advisory. “Value creation ultimately comes from cash flow and return on capital, not from the shares buyback.”

But there are companies such as DCM Shriram, J K Lakshmi Cement and Edelweiss Financials among others where buyback has worked. Analysts said many of these stocks were at rock-bottom valuations when the buyback was done.