HomeBusiness DigestAn analysis of share buybacks

An analysis of share buybacks

THIS week, focus falls on one of the most familiar concepts in investments – share buybacks. We consider the rationale as well as implications of the process.


re buyback describes the actions of a company that buys some of its own shares back from the investors or shareholders. The shares will then either be cancelled or held in treasury until the directors decide to reintroduce them back on the market.

A good example of such a development is that of Econet Wireless Holdings, which recently announced in its financial statements for the year ended June 30 that it had embarked on a share buyback scheme which saw it acquiring back more than 10 million of its own shares. The shares were later cancelled.

The process of buying back shares from shareholders can be done in three ways – market, proportional and tender buyback.

Under market buyback, shares are bought in the open market from the current sellers while in the case of proportional buyback, shares are bought from each shareholder in a set proportion to each holding.

In the case of tender buyback, shares are bought by tender from some selected investors/shareholders. The net effect of the share buyback scheme is to effectively reduce the number of shares available on the market.

The rationale

Generally, the purpose of a share buyback should be to effectively increase the net asset per share/earnings per share and will be achieved by using up surplus cash or increasing debt. Thus the option is usually recommended by directors after considering alternative investment opportunities as well as other financial considerations.

The considerations like the level of gearing, the need for research and development, possibility of beneficial takeovers, payment of a special dividend, as well as expectations that it would result in an increase in future earnings per share and is in the best interests of shareholders.

Although the share prices are market-dependent and not directly influenced by directors, the share buyback may be done mainly for the purpose of raising the share price (or reducing the trading discount).

Legal considerations

The issue of share buyback is a complex one that can only be done upon approval by the shareholders and discussion at the annual general meeting to seek their consent. Since there are some legal attachments that go with the process, the decision to embark on buyback is not at the discretion of the directors only.

The request to take on a share buyback usually takes a standard form, with specifications on the limits for the number of shares not to exceed, for example, 10% of the issued shares, the minimum price not less than the nominal price of the share and the maximum price not exceeding 5% and the middle market price for the shares for the five business days immediately preceding the day of purchase (as required by the stock exchange listing rules).

Econet, for example, indicated that the purchase price on its share buyback did not exceed the weighted average share price for the five trading days preceding the purchases.

Unless a court has been granted to the company to write down its own capital, companies can only buy back their own shares with funds they could otherwise have paid out in the form of dividends.

Tax implications

Since share buybacks will be about the investor selling his shares, there will be an element of tax affecting the shareholder’s overall return on the investments.

The tax treatment of different categories of shareholders is likely to result in different interests coming into conflict and the capital gains tax is a complicated area of tax thresholds that is made even more confusing by the application of such tools like indexation. It is probably fair to say that a proportional buyback on its own, is unlikely to take most private shareholders over a tax threshold but it may do so when combined with other dealings.

As an example: if in the tax year ended December 31 2003 a person bought 1 500 XYZ company shares at $10 and these are then sold as a result of a takeover at just over $15, then the capital gain is $7 500. If the threshold is $7 200 then this person is now liable to capital gains tax and any enforced buyback may not be welcome.

Next week we will continue with the concepts of share buybacks by further considering the effects of the process either on the investor/respective company’s shares.

*Reuben Alberto is the general manager (investments) for Imperial Asset Management Company and can be contacted through on ralberto@imperialasset.co.zw

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