Apply Buffett rule and you will know what to do with Infosys share buyback

Buffet is known to be averse to paying dividends due to better prospects of deploying capital, yet he is open to share buybacks should the Berkshire Hathway stock dip below 1.2 times its book value. NSEBSEInfosysLoading data…

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          ChartsValuation & Peer ComparisonCommunity BuzzPEER COMPANIESInfosysEXPAND TO VIEW ALL NEW DELHI: Share buybacks make sense only if shares are bought at a price below intrinsic value, so says Warren Buffett, the legendary investor.

          If that rule is followed, the remaining shares see immediate gains in intrinsic value, the Sage of Omaha wrote in Berkshire Hathaway’s annual report for 2016.

          The Indian experience has been rewarding. In the 111 cases of share buyback carried since 2014, more than two-thirds of stocks ended up offering a median of 29 per cent appreciation in the following year, shows a study by ICICI Securities.

          Five of these companies – Isgec Heavy Engineering (up 504 per cent), Garware Wall Ropes (up 250 per cent), CG Power and Industrial Solutions (up 126 per cent), Transpek Industry (up 123 per cent) and Mastek (117 per cent) – saw their share prices surge over 100 per cent.

          Share buyback has been the buzzword on Dalal Street as one after another IT majors and companies from other sectors too have announced offers either to distribute cash reserves to shareholders in a low growth environment or to push share prices.

          Indian IT bellwether Infosys has kept the market abuzz whole of past month with a Rs 13,000 crore share buyback that comes with an offer price which is at a 25 per cent premium to the then market price. The stock fell subsequently amid a crisis in the company management. And then announcements that some of the company’s promoters may participate in the buyback have left investors confused.

          Share buyback may not always be the reason behind extraordinary returns given by a stock.

          In his letter to Berkshire’s shareholders, Buffett cited an example. He talked about three equal partners in a business worth $3,000, where one partner’s stake was bought out at $900. Since each partner held $1,000 worth in business, the buyback ensured an immediate gain of $50 each to the remaining two shareholders.

          “If the exiting partner was paid $1,100, each of the continuing partners would suffer a loss of $50,” he pointed out.

          Buffett concluded the topic saying purchase price is what plays the paramount role in whether a share buyback action is value-enhancing or value-destroying.

          “For managements optimistic about growth prospects of a company, a buyback offer done at a time when the market price is depressed provides an opportunity to buy back shares at a discount to fair value, thereby enhancing the value to continuing shareholders,” the ICICI Securities said.

          ICICI Securities cited example of Garware Wall Ropes whose share buyback in 2014 saw 100 per cent success. The management had cited undervaluation as the reason for the share buyback. (See chart)

          At that point the stock was trading at 0.5 times book value and the promoters did not participate in the buyback.

          “The stock has since appreciated significantly while earnings have compounded at 46 per cent to the detriment of investors who sold their shares,” the brokerage noted.

          Just Dial’s share buyback in July 2015 was a contrasting case. The company cited lack of investment opportunities and high cash generation as the reason for the buyback. Adding to the concerns, the promoters participated in the buyback.

          “Since the buyback was announced, the stock has dipped 38 per cent CAGR to the detriment of the investors who chose to stay invested,” ICICI Securities note.

          Buffett talks about two situations where share buyback should not take place, even if the company’s shares are underpriced.

          “One is when a business needs all its available money to protect or expand its own operations and is also uncomfortable adding further debt. Here, the internal need for funds should take priority. This exception assumes, of course, that the business has a decent future awaiting it after the needed expenditures are made. The second exception, less common, materialises when a business acquisition offers far greater value than do potential repurchase of the undervalued shares. Long ago, Berkshire itself often had to choose between these alternatives,” Buffett noted in his letter.

          Buffet is known to be averse to paying dividends due to better prospects of deploying capital, yet he is open to share buybacks should the Berkshire Hathway stock dip below 1.2 times its book value. Between 2011 and 2012 Berkshire came up with three buybacks when this criterion was met.

          In India, companies from IT, healthcare, materials and Industrials sectors have seen more buyback offers due to high cash levels, lack of investment opportunities and undervaluation.

          INFOSYS CASE

          ICICI Securities noted that since Infosys’ case is not one of significant undervaluation, it is sending a neutral signal. Given the additional signalling effect of action by promoters, their participation in the buyback offer will be observed keenly, it said.

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