How to Ride Buy­back

The Economic Times - - The Edit Page Ict Trade - Pra­bal Basu Roy

The US has wit­nessed a stag­ger­ing $1.5 tril­lion worth of buy­backs by 370 S&P 500 companies over the last three years. Given the US Fed­eral Re­serve’s tight­en­ing bias, that boom could be over soon. Buy­backs were funded in an ul­tra-low-in­ter­est-rate environment through cor­po­rate debt at his­tor­i­cally high lev­els. The hunt for yield has cre­ated many ar­guably risky fi­nan­cial en­gi­neer­ing ini­tia­tives.

Re­search demon­strates that buy­backs are gen­er­ally in­ef­fec­tive in longterm value cre­ation, notwith­stand­ing the short-term spikes in stock prices due to op­ti­cally bet­ter earn­ings per share (EPS). Two key short­com­ings re­late to tim­ing the buy­back and the moral haz­ard of ex­ec­u­tive com­pen­sa­tion be­ing pos­i­tive cor­re­lated to a fi­nan­cially en­gi­neered EPS jump.

So, the key to suc­cess­ful stock re­pur­chase pro­grammes re­quires a trans­par­ent dis­clo­sure of the pur­pose, strat­egy and think­ing be­hind a buy­back pro­gramme, as an in­te­gral part of the dis­closed long-term phi­los­o­phy for the com­pany’s cap­i­tal al­lo­ca­tion pol­icy. This rarely hap­pens. In­vestors over time are, thus, un­able to judge the suc­cess of buy­backs rel­a­tive to the es­tab­lished goals.

The cur­rent trig­ger for the fre­netic ac­tiv­ity in In­dia has been the Cog­nizant buy­back an­nounce­ment lead­ing to the des­per­ate need to jump on to the band­wagon. This hur­ried com­par­i­son with In­dian IT companies is un­wise as there are sig­nif­i­cant dif­fer­ences. Cog­nizant doesn’t dis­trib­ute div­i­dends and its cap­i­tal al­lo­ca­tion pol­icy hinges on buy­backs as an ac­tive strat­egy of re­turn­ing cash.

Its ex­ist­ing stock re­pur­chase pro­gram- me of $2 bil­lion an­nounced in 2013 was com­pleted re­cently. The cur­rent $3.4 bil­lion pro­gramme in­cludes a com­po­nent of $1 bil­lion an­nounced in June 2016. Also, it uses debt to par­tially fund the pro­gramme. So, the cur­rent an­nounce­ment is not as rad­i­cal as it seems.

How­ever, ac­tivist in­vestor El­liott Man­age­ment’s con­tri­bu­tion has been to make the pro­gramme much more ag­gres­sive in terms of the re­duced time pe­riod of two years in which to ac­com­plish this, the si­mul­ta­ne­ous push for scal­ing the busi­ness along with in­creas­ing prof­itabil­ity by 3.3 per­cent­age points from the 18.7% this quar­ter, and in­tro­duc­ing a div­i­dend dis­tri­bu­tion of $700 mil­lion in its cap­i­tal al­lo­ca­tion pol­icy. While this in­te­grated buy­back pro­gramme will, in­deed, in­crease its five-year trail­ing to­tal quar­terly share­holder re­turns (TSR) of 11.75% by 1-2%, the sus­tain­able in­crease will come only from im­prov­ing its op­er­at­ing ef­fi­ciency.

The key to Cog­nizant’s TSR out­per­for­mance over the last five years — 11.75% vs the in­dus­try av­er­age of 8% — has not been due to buy­backs but be­cause of its su­perla­tive prof­itable growth from a rev­enue of $6 bil­lion in 2011 to $13.5 bil­lion now, ver­sus that of In­fosys from $7 bil­lion to $10 bil­lion.

It was here that In­fosys lost out dur­ing S D Shibu­lal’s ten­ure from April 2011 to Au­gust 2014. Its pri­or­ity is now to bridge this yawn­ing gap and Vishal Sikka’s clar­ion call to reach $20 bil­lion by 2020 should be seen in this light. Or­gan­i­cally, In­fosys can grow to a max­i­mum of $14 bil­lion, thus leav­ing $6 bil­lion of ac­qui­si­tions to bridge the gap.

In­fosys needs in­no­va­tive prod­uct and so­lu­tions companies for such ac­qui­si­tions that are only avail­able in the US whose mar­kets are at all-time highs. This should pro­vide a per­spec­tive of the ‘huge’ cash hoard be­ing touted. Of course, di­lu­tion through fol­low-on of­fer­ings and debt is al­ways a pos­si­bil­ity. But the wis­dom of re­turn­ing cash now and tin­ker­ing with the cap­i­tal struc­ture soon there­after is ques­tion­able.

It is the in­di­vid­ual mo­ti­va­tion of each com­pany in the con­text of its over­all pri­or­i­ties that de­ter­mines the pru­dence of at­tempt­ing a buy­back. Tata Sons, be­ing a 73% share­holder of TCS, needed a tax-ef­fec­tive mech­a­nism to use the cash in the af­ter­math of the Cyrus Mistry af­fair and would have in­flu­enced TCS’ de­ci­sion.

Given the ac­tive mar­ket for cor­po­rate con­trol in the US, Cog­nizant had lim­ited op­tions in the face of ac­tivist share­hold­ers. In its judge­ment, this was the best op­tion to reach a ‘stand­still agree­ment’ with El­liot. In­fosys is un­der no such com­pul­sion and must not feel un­duly pres­sured while en­gag­ing in its liq­uid­ity as­sess­ments.

A face-saver for the founders could well be a fac­tor. But then, it shouldn’t be more than a $1-1.25 bil­lion buy­back that would be re­couped through free cash flows gen­er­ated within a year. Given that its div­i­dend pay­out has been sig­nif­i­cantly in­creased to 73% of free cash flows from 33% in 2014, this would seem more than rea­son­able.

The ul­ti­mate judge­ment on this is­sue lies with the board. And reach­ing a con­clu­sion is not quite as sim­ple as it is be­ing made out to be.

The writer is a Sloan Fel­low, Lon­don Busi­ness School

No, at least in In­dia, it’s not a moun­tain

Newspapers in English

Newspapers from India

© PressReader. All rights reserved.