An EXIT To Wealth

Open offers and buybacks give a lot of scope for investors to make healthy profits if they are alert and aware of the pitfalls. But investors need to carry out their own research on the company before taking the right call. ET Intelligence Group’s Ramkrishna Kashelkar tells you how to go about it

IT will be impossible to find an investor on Dalal Street who hasn’t heard of the terms ‘open offer’ and ‘buyback’. For many, these corporate actions mean a surge in share prices and quick profits. In fact, stocks do tend to go up in most cases when an ‘open offer’ or ‘buyback’ programme is announced offering a lucrative exit opportunity to the shareholders. However, when deciding on how best to respond to them, many investors are often confused. Companies, in need of funds, raise money through qualified institutional placements (QIPs), rights issues and preferential allotments. On the other hand, cash-rich companies, utilise excess cash to consolidate their holding through open offers, buyback and delisting. These special situations offer a lot of scope for making healthy profits if an investor is alert and aware of the pitfalls.

OPEN OFFER:
Open offers have always been a preferred option for promoters and corporate acquirers and raiders to increase their stake in their firms. The Securities and Exchange Board of India’s (Sebi) ‘Substantial Acquisitions and Takeover Code’ also mandates a stakeholder to launch an open offer in certain cases. (See box: Codes Decoded)

BUYBACK:
Like dividends, buybacks are also regarded as an important mechanism through which a company rewards its shareholders. Unlike open offers, which are most often triggered by the Sebi’s guidelines, buybacks are voluntary decision by the company. Hence, it becomes necessary to check out the trigger for the company to go for a buyback.

WHY A BUYBACK?
Reasons to go for a share buyback are varied. Not all of them are published, though. A smart investor will go beyond the printed words and figures to find out if there is much more to material developments than what the company has disclosed.

Best use of capital:

A company management’s goal is to maximise shareholders’ value. If the management is unable to find lucrative enough options to deploy its funds, it is better to return the cash to shareholders. Huge unutilised cash balances tend to dampen the ratios of return on capital employed (ROCE), thereby indicating an inefficient use of capital.

Tax efficient way of returning wealth to shareholders:

Due to differential tax rates on dividend distribution and capital gains, buyback offers can be used as a tax efficient way of returning wealth to shareholders. For instance, Piramal Healthcare chose the buyback route to reward its shareholders after it sold a part of its business to Abbott Laboratories in May 2010. The company has agreed to buyback 20% of its equity at 600 each, which was at a 16% premium to the market price on the day of the announcement.

To support the share price:

An overall weak market outlook can bring down the stock price substantially.

Reaping A Rare Harvest
In such a scenario, a management may decide to support the share price with a buyback to boost investor confidence. For example, after its three buyback programmes during FY09 and FY10, Anil Ambani controlled Reliance Infrastructure has again come out with a buyback offer in February 2011 citing ‘Send a strong signal to the capital markets on the perceived under-valuation of the Company’s share price’, as one of the objectives.

To fight the impact of equity dilution:

A share buyback reduces the number of shares in circulation and hence is a great measure to fight equity dilution caused by events such as employee stock ownership plans (ESOPs) or bond conversion.

Increase promoters’ stake:

A buyback offer could be unveiled with a view to enable the promoter group to increase their stake in the company. Since the shares bought back are extinguished, those who are not participating in the offer will see their stake in the company’s overall equity going up.

The Price Detector
When it comes to open offers, the Sebi has issued guidelines to determine the minimum price at which the open offer can be made. However, there is no upper limit. According to the Sebi rules, the highest between the average prices of the past 26 weeks and the past two weeks should be considered as the minimum price for an open offer.
Buybacks are generally voluntary on the part of the company and, hence, there is no mandate on its minimum or maximum price. However, only when the company plans to delist its shares, a ‘floor price’ has to be discovered in line with the Sebi’s guidelines.
A reverse book-building process follows where retail shareholders can tender shares at any price higher than the floor price. The price at which maximum number of equity shares are tendered becomes the ‘Discovered Price’. For example, in case of a recent delisting offer by Nirma the floor price was 218, however, the final ‘discovered price’ for delisting was 19% higher at 260.
However, when it comes to how high an open offer or buyback price should go, it is the acquirer’s need and financial ability that play a key role.
For example, when JSW Steel acquired controlling stake in Ispat Industries for 2157 crore, the open offer on 23rd December 2010 came at a price which was at 13% discount to the prevailing price of Ispat. However, during February 2010 when the takeover battle for Fame India was in full swing, the open offer by Reliance MediaWorks came at a premium of nearly 64% to the then prevailing offer by Inox.
This is also true even in the case of buybacks. For instance, after the failed delisting offers by MNC subsidiaries such as Goodyear and BOC India, the delisting offer by another MNC subsidiary Atlas Copco has launched an attractive offer. The promoters indicated their willingness to buy shares at 58% premium to the discovered price of 1426. This enabled the company attract the required number of shares for delisting.

The Action Plan
An open offer or a buyback can be an exciting but temporary opportunity to make profit for investors. However, investors need to take an informed decision based on the intentions of the acquirer, the offer price and the company’s future prospects.
At the same time, keep in mind the fact that once the window of opportunity closes, the share price is likely to go back to its pre-offer levels. For example, the shares of BOC India or Goodyear fell 30-40% from their peaks on failure of their delisting offers. Similarly, the shares of Pioneer Distilleries plummeted over 50% after the open offer by United Spirits at 101 per share ended.
It is, therefore, important for investors to carry out a fundamental research on the company to identify its current fair value and expected fair value a year down the line. If the fair value in near future is likely to cross the offer price, one should hold onto his investments. It shouldn’t, therefore, come as a surprise that in four out of six open offers, which are currently on, ET Intelligence Group is recommending investors to hold onto their investments.
Another alternative for investors is to sell in the open market when the stock prices surge on news. An avid investor can actually fare much better by selling out in the market before the offer closes and covering back once the prices fall after the offer closes.

A Pitfall To Avoid
Investors must resist temptation to play the arbitrage game by buying in the open market after an open offer announcement and selling in the offer. This is risky since investors may get stuck up with a portion of their holdings, which will be worth much less in the market post-offer.
Even after an open offer is announced, the market price of the scrip tends to remain somewhat below the offer price, which one may regard as arbitrage opportunity. However, since the offer is for a limited number of shares, after the offer closes investors are likely to find themselves with a portion of their holding not accepted by the acquirer. If the market price crashes post-offer, the gains made in the offer are likely to get diluted or even negated.
For example, in case of the 2008 Ranbaxy’s acquisition by Japanese Dai-ichi Sankyo, the market price on the date of open offer didn’t reappear for nearly 28 months. If an investor had tried to buy in the open market on open offer news, she would be stuck up for long with a part of her holdings below cost. .

Conclusion
The special opportunities offered by the ‘open offers’ and ‘buybacks’ are too attractive to miss. Investors need to do their homework, resist the temptation to trade and try to estimate how things will pan out a year later to take the best call. Often, holding onto his investment, rather than taking a quick exit, could turn out to be the best strategy for an investor.

THE DISTINCTIVE FEATURES

BUYBACK
• DONE BY the company itself
• GENERALLY, the number of shares reduce after a buyback
• BUYBACK can be through open market operations or through the tender route
• BUYBACKS, are voluntary on the part of the company
• THERE is a maximum limit or ceiling up to which a company can raise its equity through buybacks during a year

OPEN OFFER
• DONE BY promoters or any other third party other than the company
• OPEN OFFERS, don't result in change in the number of outstanding shares
• OPEN OFFERS are typically through the tender route only
• IN MOST instances, open offers are mandatory rather than voluntary
• THERE is a minimum limit of 20% with no maximum limit in case of open offers