Buyback of shares to benefit companies

KARACHI: The proposed amendments to the Companies Ordinance 1984 will allow companies to buy back their shares and reclaim them as treasury shares, which may be re-issued, should the companies require additional financing through equity sales, The Express Tribune has learnt.

The law in its current form dictates that any shares repurchased from the market by the issuing company must consequently be cancelled.

Companies generally have three avenues for repurchase – repurchases from the open market, tender offers and block deals with large shareholders.

Not all companies will stand to benefit from the amendment. InvestCap Head of Research Khurram Schehzad explained, “A share buyback increases the earnings per share (EPS) of the company only when the earnings yield stands above its after-tax cost of debt. Buyback will add value to the company as long as its earnings yield is higher than its after-tax cost of debt.”

The analyst highlighted some advantages of the amendment for listed companies, pointing out that companies can avoid unwelcome takeovers by reducing the outstanding free float of shares.

“A company can also use the buyback as an alternative to issuing dividends to shareholders,” said Schehzad, adding, “this will also increase tax efficiency as, unlike dividends, buybacks are not double taxed.”

He also asserted that the amendment would help improve price discovery at local bourses, as companies, whose shares are currently undervalued in the market, would likely move to repurchase some of their free float. “In essence, a single buyback activity can hold multiple benefits for a company and its shareholders,” he added.

“The basic criterion for eligibility under the amended law includes a current ratio greater than 1:1 and a debt-to-equity ratio of less than 6:4,” said Schehzad. “While 42 companies are currently meeting this criterion, only about 13 are in a position to benefit from any buyback activity,” he explained.

Schehzad believes the amendment will be extremely beneficial in the long term. “If it is implemented in true spirit, companies will be better able to maximise shareholders’ wealth,” he added.

Published in The Express Tribune, March 3^rd, 2011.