TCS Buyback: How Will it Impact Value, Control & Price?

At its board meeting on February 20th, the Board of TCS approved the buyback of 5.61 crore shares subject to a maximum outlay of Rs.16,000 crore. That means TCS can buy back the shares at a maximum price of Rs.2850. Normally, buybacks are done through any of these 3 methods viz.

• Proportionate Tender Offer to existing shareholders.
• From the open market via book-building or stock exchange route
• From odd lot shareholders

TCS will be conducting this buyback of 5.61 crore shares via the Proportionate Tender Offer route to its existing shareholders. The total of 5.61 crore shares that are proposed to be bought back by TCS will constitute 2.85% of the total paid up capital of TCS.

Background to the TCS buyback offer and the timing…

There have been demands from institutional shareholders that IT companies sitting on loads of cash distribute benefits to shareholders in the form of buybacks. The entire debate was triggered off when Cognizant announced a $3.4 billion buyback of shares a couple of weeks ago. This was followed by strident demands from investors and ex-employees of Infosys to buy back shares as a means of rewarding shareholders. Major IT companies like TCS, Infosys, Wipro and HCL Tech are estimated to be sitting on a combined cash pile of $16 billion. With limited opportunities for large capital investments or for strategic acquisitions and mergers, there have been strident demands for distributing this cash in the form of special dividends or in the form of buyback of shares. The TCS management had indicated about the likelihood of a buyback on February 15th and therefore the announcement on Feb 20th was a logical culmination to the same.

Understanding the shareholding structure pre and post-buyback…

The following table illustrates the pre-buyback shareholding pattern of TCS as on Feb 17, 2017

Source: TCS Exchange Filing

As the table above suggests the promoter group consisting of Tata Sons principally and a few group companies own nearly 73.31% of TCS. Since this is a proportionate buyback, even if all the shareholders tender their shares in the said proportion, the post-buyback stake of the TCS promoters will continue to remain at 73.31%. Thus from the Tata Sons point of view there will be no dilution of equity stake in the event all shareholders including the promoters participating in the buyback offer. But what is more likely to happen is that institutions, HNIs and retail investors may look to exit their holdings in a bigger proportion as the price of Rs.2850/- is very attractive as it is closer to the recent highs touched by TCS. For most of the institutional investors this move will enable them get out of the stock at its high price. In that event if the Promoter Group chooses to forfeit its buyback rights to the other shareholders then the promoters will end up holding 144.45 crore shares out of a reduced paid-up capital of 194.19 crore shares thus resulting in the promoter group’s stake in TCS increasing from the current level of 73.31% to 74.39%.

For TCS, this takes care of the short-term clamour of shareholders…

The major question confronting TCS was, what will they do with the cash stash of Rs.39,000 crore in their books. With the buyback taking care of nearly Rs.16,000 crore of this cash pile, the media and the institutional shareholders will have little to complain about. To that extent, it should take care of the short term clamour which has grown strident around this subject. If the promoters opt to participate in the proportionate buyback, then for them it represents a smarter and more economical method than getting dividends. Remember, dividends attract 15% dividend distribution tax (DDT) and an additional 10% tax in the hands of shareholders if the annual dividend income is more than Rs.1 million. In the event of the promoters opting to forfeit their buyback proportion in favour of other shareholders, they will anyway stand to increase their share in TCS. It would be instructive to remember that Cyrus Mistry holds TCS shares worth Rs.1000 crore in his individual capacity and it will be interesting to see what he does with his shares.

Do buybacks really add value to shareholders?

Back in 2005, McKinsey had done an in-depth study on whether buybacks add value to shareholders. The finding was that minority shareholders do not gain much from buybacks. Firstly, in the Indian context most small shareholders are outside the ambit of dividend tax. Hence the arbitrage of buyback over dividends is not relevant for them. Secondly, the same profits are distributed over lower number of shares and hence the EPS will go up. However, McKinsey’s finding was that markets viewed buyback as an indication that the company did not have too many capital investment opportunities and that resulted in depressing the P/E of these companies. Therefore the increase in EPS was compensated by the fall in the P/E with the result that the net impact on valuations was negligible. If one looks intuitively at the buybacks in India in the recent past, McKinsey’s findings are almost corroborated.

Buybacks have been generally beneficial for promoter shareholders. It either offers them a dividend arbitrage without loss of control or increases their hold over the company. It will be interesting to see how this TCS buyback shapes up for Indian shareholders!