Infosys buyback offer: An arbitrage worth considering

Should investors take the Infosys buyback offer? Here’s how to think about it in terms of arbitrage.

A year ago, the share was trading at ~1,075; two years ago, it was trading at ~1,175. Say, an investor holds X shares bought over a year ago. Those shares are now offered.

If the entire holding is accepted for buyback, there are tax-free profits. The investor can either park those elsewhere or buy more Infosys shares at prevailing prices, post-buyback. In the latter case, he or she may gain something and retain a longterm holding, if the post-buyback price is lower. Given the current internal conflicts, prices may well be depressed after the buyback ends.

If the investor has bought the shares more recently than a year, capital gains tax will swallow approximately onethird of profits. The stock was trading close to a twoyear low in the ~885-900 zone, after the resignation of Vishal Sikka.

The company has an EPS of about ~62 at the moment, and assuming that the business remains stable, the buyback suggests a valuation of PE 18.5, which is on the higher side for a company growing profits in singledigits. However, Infosys will still have a plenty of cash reserves and that’s not to be sneezed at.

Now let’s look at likely complications. First, if “everyone” offers shares, the buyback ratio will not be 1:1. There will be a lottery akin to an initial public offering (IPO) where a certain number of offered shares will be accepted for buyback. We can only guess what that ratio will be. If a lot of investors, including some large shareholders take the offer, the ratio of actual buyback to offered shares will be low.

This means that those who pick up the stock from the market to offer it for buyback, must assume that they are left holding some stock they have picked up and they will have to pay capital gains on any profits they make. Will this be worth it? We can't tell. We can make a guess at buyback: offer ratios by looking at trading volumes and delivery ratios but that's only possible close to the record date.

Logic does suggest that a lot of shares will be offered since Infosys is in trouble at the moment and the current price is low in comparative terms. There are also chances of more scandals if something nasty surfaces about the controversial Panaya deal, or price may be impacted by potential classaction suits in the US. Those negative factors will probably influence a lot of people to offer shares.

A contrarian might look at this another way. The company cannot remain headless. That will improve for sure though the next chief executive officer (CEO) may be no better or worse than ( Vishal) Sikka. The business should pick up if demand for IT services picks up. Change in the business model is inevitable — the old labour arbitrage model is on its way out.

Whatever happened with Panaya, Infosys still has cash post-buyback, which it can use to acquire entry to spaces like AI ( artificial intelligence) and digital. Class action suits are imponderables. But, nobody wants to destroy their own shareholder value so it’s possible US investors will refrain if they think Infosys is on a recovery path. This could mean the current prices make the stock attractive for longterm players.

It may make sense to buy off the market and offer for buyback. Whatever the buyback ratio, it will reduce the effective acquisition price of the holding. If there’s a postbuyback slide in prices, the investor could use that as a second entry point. There are no guarantees of course and the risks are obvious. But, it’s certainly worth considering.

A year ago, Infosys share was trading at ~1,075; two years ago, it was trading at ~1,175. Say, an investor holds X shares bought over a year ago. Those shares are now offered