Share buybacks – An excellent defensive tool in a weak market

AS October 2018 ended, the FBM KLCI closed lower by 4.9%. Malaysia’s performance is still commendable as it is only below that of India’s Sensex Index, which is higher by 1.1%, the Nikkei 225’s 3.7% decline and the Bangkok’s SET fall of 4.8% year-to-date.

Other markets in the region have performed relatively much worse with losses ranging from as low as 7.9% for the Taiwan Stock Exchange Weighted Index to as high as 31.9% for the Shenzhen’s Composite Index.

In a down market and if the selling pressure persist, one of the mechanism that is available for listed companies is to buy back their own shares, i.e. after obtaining the mandate from shareholders, which is typically obtained at every AGM.

A share buyback programme allows a company to purchase up to 10% of its issued and paid-up capital. Over the past four days up to Nov 1, 42 companies bought back their shares with 12 of them being active even on a daily basis while eight others, at least three out of four trading days.

Increasingly, we are seeing more listed companies undertaking share buyback exercises, which may help the company’s share price from experiencing a larger-than-expected drop in their respective share prices as well as to provide support to shareholders, who believe in the long-term value of a company’s business operations as well as the outlook.

However, the question is, what do companies do with the shares that have been bought back?

Under the Bursa Malaysia Main Market listing requirement, share buybacks must be made wholly out of the share premium account or retained profits or both and there is no restriction for companies to either utilise funds which are internally generated or via external borrowings.

However, it is rather perplexing to see if a company funds its share buybacks via borrowed money. Two things. One, it’s a sign that the company thinks the share prices are just too cheap to ignore and do not mind using borrowed funds to purchase the shares.

Two, the company is using borrowed funds to purchase own shares to support its major shareholder(s), which may be a right or a wrong thing to do, especially if the major shareholder(s) have shares pledged as collateral for banking facilities. In this instance, the use of share buybacks to defend shareholder(s) is not a right thing to do and hence it is seen as detrimental to minority shareholders.

For companies that used internally-generated funds that are deemed to be their cash reserves, the above points too are valid but an additional point is brought to question as the intention of using the cash reserves for share buybacks as the company’s cash can be better used such as higher dividend or for expansion of business operations.

Under the listing requirements, companies who purchase shares have three options on the table. The first option is to re-sell the shares in the market, presumably at a higher price than the average purchase price in the books.

In this way, the share buy-back programme is a cushion during market sell-offs and a company can actually profit from selling the shares. For example, in June, Public Bank sold some 20.6 million shares in the market for shares it had previously bought back for RM475.5mil.

These shares were accumulated and bought over the years with the last buyback done almost seven years prior to the last re-sale in June this year.

Under the second option, the shares, which are held as treasury shares, are re-distributed to all shareholders in the form of dividend in specie. Under the first and second option, the shares are re-floated and the original share buyback entered into is negated entirely, although in the first option, Public Bank has proven that its share buyback is beneficial to its shareholders.

The third option is for companies to actually cancel the re-purchased shares, which allows the company to reduce the total shares outstanding and enhance both the company’s earnings per share (EPS) and net asset (NA) values.

While accounting-wise shares which are held in treasury prior to the exercise of option one or two, also enhances EPS and NA value, the act of cancelling shares which are bought-back is a permanent move for sustained enhancement in value of a company rather than leaving an option open for the shares to flood the market again in another form, especially via distribution in the form of a dividend in specie.

The idea of a company selling back the shares it has bought back is not well accepted in the market as it can be seen as the company’s own believe that perhaps the company’s share price has reached its peak.

There are also other options available for companies to use the share that are bought back, i.e. to either transfer the shares for the purposes of an esos scheme or even to transfer the shares as purchase consideration for acquisition of an asset or company.

To understand market activity related to share buybacks, it’s worth noting that the total trading volume and value that was carried out in the past four days from Oct 29 to Nov 1 were about 25.73mil shares with total market value of RM19.48mil.

The top three active share buy-backs that were carried out in terms of volume were from MyEG, Titijaya and Salcon, accounting for 40% of all buy-backs in the market.

In terms of value, MyEG, KPJ, and E&O occupied the top three spots and accounting for 47% of total value traded.

Judging by the market action over the past four days, listed companies are not utterly aggressive in defending their respective share prices despite the market experiencing one of its steepest pullback in months.

Perhaps, the notion that share buybacks is a good defensive tool may not be applicable to Malaysia after all.

Worse, are companies whom year-in and year-out request shareholders to vote for the mandate allowing the board to carry out share buyback programmes but the companies are inactive in the market, despite the market’s weakness.

Interestingly, other than almost three million shares bought back by Genting Malaysia between Oct 15 and Oct 18 and some some nibbling by MISC of less than 50,000 shares on Oct 23, none of the other 30 KLCI constituents were in the market to carry out any share buyback during the market’s pullback in October.

Perhaps, that is reflective of the market’s direction too or maybe for the top 30 index stocks, share buyback is not something they carry out frequently or in some cases, never.

Perhaps minority shareholders should be given a better explaination as to why the board did not carry out any share buybacks despite obtaining shareholders’ mandate every year and especially if the share price of the company has dropped significantly.