Ever wondered why a board opts to buy back the company’s shares? A share buy-back is almost always the subject of a shareholders’ resolution at each AGM of an issuer.
Common sense dictates that boards resolve to pursue a share buy-back arrangement under the following circumstances:
- A discount exists between the current market price and the embedded / net asset value of the share;
- Company has sufficient cash reserves;
- Sluggish trading conditions;
- Little debt.
Several arguments for and against share buy-backs can be developed, and we deal with a few of these below.
Arguments for such a programme:
- With fewer shares in issue, the value will gradually rise. This is a weak argument. As buy-backs seldom exceed 3-5% of the number of shares in issue which would hardly cause a ripple in the market price.
- Share buy-backs create trading activity in the share. This argument is of course only valid if trading is thin. In any event the company is trading against its own shareholders, particularly those that are not aware of the existence of the buy-back programme.
- A rise in the share price has a positive effect on the outlook and motivation of senior executives.
For example, Berkshire Hathaway owns somewhere around 5 percent of Apple. Warren Buffett recently noted happily, “with the passage of a little time, I figure we might own 6 or 7 percent simply because Apply bought back so many shares.” He added, “I love the idea of having our 5 percent or whatever it may grow to 6 or 7 percent without us having to lay out a dime.”
Arguments against a share buy-back programme:
- Buying shares creates an artificial short term price level in the market. Unless potential buyers are aware of the company’s buy-back programme, they may be misled to think that the market is on the rise. Almost like a form of legal stock manipulation, pushing up prices not because the company has performed well but simply because there are fewer shares to trade.
- It poorly reflects on the ability of management and the board to grow and expand the business. Share buy-back offers an easy way out. Spending cash resources is not the best way for a company to gain the support of shareholders. Perhaps consideration should be given to refresh the board with new appointments.
- A short term softening in the share price should not be seen as an opportunity to begin buying shares on the open market. With an open mandate granted the board at the last AGM, shareholders would never know if they are trading with or against their own company when selling or buying shares.
- This approach avoids the payment of dividends, which would be taxable in the hands of the shareholder. This argument is weak. It pre-empts the option of many shareholders who would rather receive a dividend. Unless they are sellers at the same time as the company is buying, no benefit is to be had by them.
Some of the parts market price
A small number of listed investment holding companies with underlying listed subsidiaries, on a daily basis reflects the aggregate Some of the Parts (“SOTP”) market price per share of these investments. This is to enable readers to measure the market price of the holding company shows the discount that exists. Merely providing the information transparently to shareholders in itself might work in favour of a reduction in the price discount to the share price of the holding company. For a good example refer to PSG Group at http://psggroup.co.za/sotp/
Share buy-backs point to a focus by management on share price performance. The long term incentive programmes operated for the benefit of executives, invariably benefit from a rise in share prices. This is a most unhealthy situation. Shareholders should be concerned about granting the board the authority to buy back shares. This is an important role for the independent non-executive director, amongst others.
Shares bought in this manner are usually not cancelled but held as “Treasure Shares” by the company. In this way, no shareholder approval for the re-issue of such shares is needed, as it was approved by shareholders sometime in the past. Notwithstanding this, several boards are known to ask shareholders to authorise it to issue shares as and when deemed necessary, including applying “Treasury shares” for such purpose.