10 key takeaways from the TCS buyback announcement

The TCS buyback announcement was more a matter of when rather than whether? On 20th February the TCS board announced the buyback of 5.61 crore shares at a maximum price of Rs.2850/share. This will involve a total allocation of Rs.16,000 crore of cash from the company’s massive cash pile. That will surely gratify the shareholders and the media in the short term as they have been clamouring after large IT companies to reward shareholders with special dividends or buyback offers. Here are 10 key takeaways from the TCS buyback announcement

Key takeaways from the TCS buyback announcement…

  1. The TCS buyback of 5.61 crore shares represents 2.85% of the total paid up capital of TCS. Out of the total cash pile of Rs.39,000 crore in the books of TCS, this buyback will use up nearly Rs.16,000 crore. That still leaves TCS with a chest of $3.5 billion for its proposed inorganic growth plans.
  1. Of late buybacks have emerged as a more tax efficient method of rewarding large shareholders. Dividends paid out by an Indian company attract 15.5% dividend distribution tax (DDT). In addition, large investors earning more than Rs.1 million per year as dividend will pay another 10% tax on dividend income. This is virtually tantamount to double taxation of dividends. Buyback is a method of rewarding shareholders by circumventing the steep taxes on dividend payouts.
  1. In India buybacks can be made by companies either through the proportionate tender offer method, reverse book building method or through odd-lot shareholders. TCS proposes to complete the buyback exercise through the proportionate tender offer method.
  1. The demands for a buyback from IT companies started after Cognizant announced a $3.4 billion buyback and key shareholders of Infosys also started demanding that the company buy back shares. Normally, companies that are sitting on a cash pile but do not have adequate investment opportunities adopt the buyback route.
  1. Currently, the shareholding structure of TCS is dominated by the promoter, Tata Sons. In fact, Tata Sons and group companies put together hold 73.31% of the paid up capital of TCS. Domestic and global institutions hold nearly 22.20% of the paid up capital while the balance is distributed among retail investors and body corporates.
  1. There are two possibilities in this case. If the TCS promoters also accept the proportionate buyback offer, then their shareholding remains the same in the reduced paid up capital. However, if Tata Sons chooses to forfeit its buyback in favour of retail and institutional shareholders, then it will help Tata Sons consolidate its holding in TCS from 73.31% to 74.39%.
  1. How will large shareholders react to the buyback offer? Most retail shareholders will find the buyback offer quite attractive as the price is fixed closer to the higher end of the H/L range. This will be a boon for shareholders who are sitting on notional losses on the stock since anyways most institutional investors are not very positive on the long term prospects of the IT industry in India considering the limited visibility in terms of revenues and global IT spending.
  1. Have buybacks added value? That is a very important question that investors need to understand. According to a report published by McKinsey in 2005, buybacks either destroy value or at best keep the status quo on value as far as minority shareholders are concerned. This is more so in case of a country like India. Small investors do not benefit from the arbitrage between dividends and buybacks as they are anyways not covered under dividend taxation. Also what small investors gain technically in terms of higher EPS, they lose in terms of lower P/E. Thus the net effect of a buyback is either negative or, at best, neutral.
  1. Buybacks are normally beneficial to the promoter groups. There are 2 key reasons for this. Firstly, in case the promoters tender their shares in the open offer then they can make tax-free income without reducing their stake in the company. Alternatively, if they choose to forfeit their buyback in favour of other shareholders, then the promoters tend to increase their stake without infusion of any additional investments. That could be a key driver for Tata Sons which is anyways looking to consolidate its hold over the group, especially after the open challenge posed by Cyrus Mistry and Nusli Wadia. After all, TCS continues to be the crown jewel for Tata Sons in terms of profitability and market value!
  1. From the perspective of TCS, this will address the medium-term furore over buybacks in the media and the analyst community. Of course, the onus will now be on Infosys to follow up on what TCS has done. What TCS needs to be cautious about is that such a large payout to shareholders normally coincides with a fall in valuations. That is something that TCS needs to be cautious about!

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