From THE HINDU group of publications
Sunday, July 01, 2001


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Market-based buybacks -- SEBI must end this malaise

S. Vaidya Nathan

THERE appears to be a fairly strong case for the Securities and Exchange Board of India (SEBI) to consider disallowing buyback of equity through the secondary market route.

For sure, this might sound anachronistic since we have constantly advocated market-based systems vis-a-vis the regulatory framework.

But such a move appears warranted as there is evidence that promoters in India Inc are misusing the market buyback to serve their ends. But such a move should not be permanent. It should be allowed only when there is clear evidence that India Inc will use regulatory facilities in the best interest of its shareholders and, more important, stop using public funds to serve private purpose. The latter has been the underlying theme of a number of recent buybacks.

With the exception of India Nippon, a string of companies has taken the secondary market route for buyback. Though the buyback is usually with a maximum price tag, almost all of the secondary market buybacks have been completed at a much lower price than the maximum price fixed.

Of course, this is intrinsic to such a mode of buyback. Also, the secondary market buyback is perhaps the preferred option when stock prices are sluggish, for the company can complete it at lower cost. And such a scheme would benefit the shareholders staying on.

All this is perfectly in line with the market-based buyback in the US by companies big and small. But one crucial element has been missing in the Indian context: The lack of surplus funds that can be returned to shareholders for want of better prospects.

Indeed, a buyback makes sense only if a company has cash over and above what is required to ensure that its growth prospects are not affected. Otherwise, the buyback would be only value-depleting rather than -accretive. Let us look at some of the more prominent cases of buybacks.

* GE Shipping: This is a classic case of a company with promoters having a thin shareholding, of 12-13 per cent. A hostile bid had been mounted for a sister concern -- Gesco Corp in which the promoters had a similar stake -- and the promoters managed to fight back with the Mahindra group coming in as a white knight. Close on the heels of the development, the Great Eastern Shipping board proposed a buyback at a price not exceeding Rs 42.50 per share. This was completed at Rs 34 on an outlay of Rs 150 crore. Just two weeks later, a second round on similar terms was announced. These two take the promoters stake to around 20 per cent.

GE Shipping, a capital-intensive entity, had a good year after three-four difficult ones. The Rs 300-crore that would be spent on the buyback is unlikely to be in the nature of ``surplus cash for buyback purposes''. Quite clearly, the whole exercise was intended to push up the promoters' stake.

* Bombay Dyeing: This is almost similar to GE Shipping except that there is an accumulation of its own shares by the Bajoria group. It has not come to the stage of an open offer. But the beleaguered promoters have announced a buyback at a maximum price of Rs 60 through the secondary market.

Given the kind of difficulties that Bombay Dyeing has been going through, it is tough to take the view that the company would have surplus cash that can be returned to shareholders to cut the equity base and benefit the shareholders staying on.

* Britannia Industries: This is perhaps the least expected buyback. It is also a company in which Nusli Wadia (of Bombay Dyeing) controls a sizeable 22 per cent. This company announced a buyback along with Bombay Dyeing -- perhaps to signal that the latter's was not an effort at bolstering the promoters' stake.

But Britannia, whose buyback is at a maximum price of Rs 750, can hardly be said to be in a position to fork out Rs 55 crore. Unlike the others, it is comfortably placed on earnings and cash flows for many years in a row. But at a time when competition with deeper pockets is breathing down its neck, it can hardly afford to splurge in this manner.

These three cases are symptomatic of the misuse of buyback by Indian companies as well as MNCs to suit the ends of a narrow group of shareholders. If, indeed, the cases of buyback in the last one year or so were made genuinely with surplus cash, with an intent to signal under-valuation and correct it and also ensure better valuation for shareholders staying on, then, that is not reflected in the stock price trends.

This is as tell-tale an indicator as any of what the market thinks of these buybacks. Not serving these objectives means the buyback is basically an useless exercise for the shareholders staying on. Perhaps, SEBI should make an empirical study to show how secondary market based buybacks have been misused.

In the other two modes -- tender and auction -- shareholders clearly know what they would get and the company would also have to think long and hard. But in the secondary market route, company funds can be merrily thrown around to serve the ends of promoter groups and benefiting neither the non-promoter shareholders staying nor those exiting.

What was feared when the buyback was introduced -- that it would be misused by promoters -- seems to be coming true. This is as good a reason as any for SEBI to end this malaise till India Inc can learn to treat public funds and shareholder interest with the respect that is due.

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