Cos eager for share buyback

As of now, under Section 77 of the Companies Act, 1956, a company cannot purchase its own shares from the open market. However, the Companies Bill, 1997, has a provision which will allow companies to buy back its own shares subject to some conditions. The major stipulation is that a company can buy back shares purely for equity restructuring only and not for making profits by buying and selling its own shares.

“This means companies which go in for share buyback will have to extinguish the equity capital to that extent. This will enable companies to boost the book value and earning per share (EPS). “When companies are given freedom to issue capital, they should be allowed to buy back these shares. This will enhance the shareholders value,” said a senior director with a corporate house. The buyback system is common in the UK and several other countries. As buyback leads to reduction of equity capital, a company can push up the EPS through this route. Of course, this will result in further appreciation of the share price of the company on the stock exchange.

If more companies come forward for buyback of course the actual buyback can materialise only after the parliament passes the new Companies Bill it can become a major factor in turning around the fortunes of the stock markets as well. It will also send a positive message to the investment community about the management perception that the company’s share is undervalued.

Many companies have already announced the amount to be invested in buyback. Godrej Soaps, for example, will be investing Rs 25 crore and Jindal Strips Rs 40 crore on buyback. As per the proposed provisions, this amount can be raised from the share premium account, free reserves or any issue specifically for this purpose. However, as corporate sources pointed out, transparency in buyback operations is needed especially against the background of insider trading allegations involving Hindustan Lever and Asian Paints.

However, some companies have reportedly started manipulation to take advantage of the buyback scheme. Said Morgan Stanley’s Dean Witter, “In view of the steep fall in the prices of several second-line stocks over the past two years, it appears that managements are tempted to buy back their shares before the official guidelines have been clarified. Some are already buying their companies’ shares, parking them temporarily on the books of subsidiary finance/investment firms.”

But much will depend on the smooth passage of the Companies Bill in the parliament. The fate of the Insurance Bill which was withdrawn following strong protests from some parties has prompted corporates to cross their fingers when it comes to the Companies Bill.