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Mixed reactions greet Cabinet nod to buyback proposal

The Union Cabinet today approved a proposal to amend the Companies Act, 1956, to enable companies to buy back their shares from the stock market.

Announcing this after a Cabinet meeting that lasted more than two hours, an official spokesman said the modalities for giving effect to the decision are being worked out.

He said the Cabinet also discussed the announcements made by Prime Minister Atal Bihari Vajpayee at the annual meeting of the Federation of Indian Chambers of Commerce and Industry on Saturday.

According to sources, the amended laws relating to buying back of shares will be effective from the day of notification by the Department of Company Affairs.

Various committees had in the past recommended allowing repurchase of shares by companies. A detailed note on the proposal was circulated in the Cabinet last month.

The government has proposed to amend certain sections of the Companies Act to permit the companies to deal in their shares. The 42-year-old Act prohibits companies from buying their shares from the stock market.

Buyback received a mixed reaction from stock-market participants, with some welcoming it while others cautioned that the step would lead to an unhealthy impact on the finances of firms that resort to the option.

A section of stockbrokers felt buyback is unlikely to have a healthy effect on companies, which have undertaken large capital expenditure. "The buyback scheme will have a negative impact on companies that have heavy capital expenditure on hand. It will make sense only for those companies that do not know what to do with the surplus cash," Prime Finance senior executive P S Sheth said.

"Buyback could have a two-pronged effect on the scrip. It could either push up the stock price as it dries up the float or improve the earnings per share as the number of shares is reduced," said Yogesh Patel, executive director of DCM Finance Consultants.

''While some companies are perceived to be cash-rich, the markets may actually react adversely to a decision to buy back their shares. Not because they do not generate cash, but because they have more capital expenditure in the pipeline. Also, for most of these companies, investments in their business end up giving higher returns than what buyback can offer," Patel added.

Swan Finance Managing Director Atul G Shah said that for multinational companies , buyback may not give their stock prices a major boost. "This is because of the high discounting given to MNCs . There are hardly 12 MNCs that can go for buyback. Market men predict that even Hindustan Lever will manage to buyback, with its present market capitalisation, only 1.75 per cent of its equity capital."

Even buying back shares with borrowed funds is ruled out as companies that are quoting below their book value tend to have a low return on net worth, Shah added. "So, if a company borrows funds at 16 per cent and is able to generate only 12 per cent , its profitability will naturally be eroded."

Buyback will also result in cash outflows and a reduction in equity, which will increase the gearing of the company. When gearing is high, banks will be reluctant to lend to such companies. Why should a company reduce equity and improve its share price, if it does not plan to tap the capital markets later with an issue?

Companies that plan to borrow funds and go in for buybacks may fall into a trap as the returns from such an exercise will not justify it, Shah said.

National Stock Exchange senior broker Girish C Parikh said market sentiments have improved for the time being. But it is unlikely that the rally will last beyond 150-200 points. The improvement in sentiment may only provide an exit for many non-Indian investors.

The industrial climate and capital market will improve, improving investor confidence, a leading broker said. He expressed confidence that the government would implement its promised package within a year.

Improved industrial performance will aid loan recoveries, helping to curb the growth of non-performing assets with banks, a leading banker said.

While the total impact of the package will be seen over the next two years, bankers suggested that the government should also make vigilance and audits more practical to facilitate speedy implementation, Parikh added.

UNI