Share buybacks pushing down market liquidity

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IT has become quite common for AGM agendas to include a proposal for the company to buy back its own shares.

Tafadzwa Chinamo

In accordance with listing rules, the notices should inform shareholders how the shares will be bought, at what price and over what period.

What is seldom left out, perhaps on the assumption that share buybacks are now routine, is the reason why the board feels this is a good thing to do.

Fair enough, share buybacks are very common in advanced markets to the extent that there are funds whose overriding objective now is to buy shares of companies buying back their shares.

What makes the practice worrisome for Zimbabwe, however, is the already illiquid market and chronic cash crunch choking most listed companies. Buybacks make this situation worse by reducing the number of shares in circulation.

How do these companies justify spending cash on buying back their own shares rather than providing that capital to the business? Add to this the prevalence of owner-managers on share registers, share options, and failure to raise much-needed capital, then you start to appreciate an outsider’s raised eyebrows.

Conventional wisdom tells us that when a company makes a profit there are typically two ways such profits can be applied. The profits can be reinvested in the business under the cliché “preserving capital”.

They can be paid out to shareholders as dividends or share buybacks.
Share buybacks are therefore an alternative to dividends. The shares so purchased are either retired/cancelled or kept for treasury purposes, and are available for re-issuance, usually to a strategic investor.

In Zimbabwe, and for the purpose of this article, shares are mainly repurchased for cancellation and by so doing reduce the number of shares in issue.

This reduction means that even if profits remain the same or decline slightly, the earnings per share increase. Equally, buying back shares that are deemed undervalued, another common reason for share buybacks, benefits the non-selling shareholders (insiders) at the expense of usually unsophisticated small shareholders who are more likely to sell to the company when these shares are undervalued.

On occasion the need to repurchase own shares is summed up by a statement company bosses think their shareholders want to hear: “The share buyback signals the board’s confidence in the future of the company”, suggesting that no one else is seeing the value.

Perhaps such confidence explains why S&P and Dow Jones indices report that US companies spent US$105,2 billion buying their shares, significantly more than the US$70,9 billion spent on dividends during the first quarter of this year.

The numbers are even more staggering when the US$174 billion Exxon Mobile spent on buybacks in the 10 years to 2010 is thrown in.

Microsoft was not far behind, spending US$110 billion.

Interestingly, Apple, under pressure from a corporate activist to do something about its cash pile, announced a US$60 billion buyback. Buybacks therefore are the chief way companies return cash they don’t need to shareholders.

Given the overwhelming desire by large US companies to cannibalise their registers, what would justify raised eyebrows when Zimbabwean companies do it on a relatively insignificant scale? A lot, actually. The majority, if not all Zimbabwean share buybacks, fail one key test; the share buyback is not put forward as an alternative to paying a dividend.

Zimbabwean companies announce share buybacks regardless of poor financial performance.

As a matter of fact, it’s when performance is suspect and fails to excite the share price that buybacks are conceived. Besides there being no dividend option for shareholders to consider, at times cash flows would actually be zero or negative, an accounting paradox to prudent allocation of scarce resources.

Failure of this litmus test leads to speculation that perhaps there is more to our share buybacks than meets the eye. In order to understand why our buybacks are not alternate to dividends, a closer look into the topology of shareholding structures might provide an answer. This includes illiquidity of shares which are frequently split to improve free flow; share options, and the desire to manage costs associated with large share registers

Skewed shareholder profiles
A glance at tables of top shareholders on the back pages of annual reports of Zimbabwe Stock Exchange (ZSE)-listed companies immediately reveals dominance by small groups of shareholders.

Unlike listed companies in the developed world, it’s not uncommon for Zimbabwean owner-managers (insiders) to individually or collectively own up to 51% of a company. In developed markets owner-managers do exist mainly as a result of them being the founders, which is not necessarily the case here.

This makes insiders very wary of anyone showing interest in buying sizeable shares in the company. To allay such fears, proactive strategies to manage access to the free float are often adopted, and a share buyback tops the list as it reduces the number of shares available to an unwelcome investor and after cancellation increases the percentage of the company the insider already controls.

The second point to consider is the illiquidity of the ZSE. According to visiting foreign fund managers specialising in emerging markets, daily turnover of at least US$1 million per counter per day is considered liquid.

Such turnover ensures genuine price discovery and ability to easily purchase or sell shares without distorting the price. Zimbabwe is far from this, hence is classified a frontier market. In this category, the global ZSE turnover which bops around the US$1 million level is considered reasonable but not ideal to excite mainstream fund managers and investors. It needs to improve.

It therefore works against everyone when instead of increasing, market liquidity is reduced as a result of share buybacks shrinking free floats.

Such a reduction of shares available for purchase in the open market subjects the share price to surges whenever “big” bids and offers are placed.

This gives insiders unfair leverage to extort high bids for their shares which serve to bolster their portfolio values (quite handy if the shares are securing a loan).

It also makes it difficult for strategic investors to take positions, thus entrenching insiders’ hold on companies. This is self-defeating given our dire need for capital and strategic investors.

Surprisingly though, these strategies have occasionally worked too well to the extent that even insiders struggle to offload small parcels of shares to cover incidental expenses. The result? Share splits. These in turn create very small shareholders who will eventually be targeted in the next share buyback.

Share options in the context of buybacks reveal more self-interest motives. Share options only make sense when the share price moves up.
So it’s not surprising that shareholders who are employed by the company would find it beneficial to devise strategies such as share buybacks that increase the share price.

Unjustifiable cost savings
The fourth reason why share buybacks are being done, we are told, is to save costs in administering bloated share registers, especially if the bulk of the shareholders hold insignificant number of shares.

Such small shareholders, the companies argue, disproportionately
balloon the cost of producing and distributing obligatory documents such as annual reports. This, we are further advised, in addition to dividend processing in a manually-operated environment, becomes unsustainable. Zimbabwe won’t be in the dark ages for long, so we wait to see how this pans out.

Even without automation (accepting this as a reason) this points to an admission that we have companies that are too small to be listed on the ZSE.

Surely, a listed company in Zimbabwe should be able to cough up US$100 000 per year on shareholder administration and secretarial services without choking.

When all is said and done, there is really nothing illegal about share buybacks, so taking pot shots at them may appear misplaced and vindictive.

This is not the purpose of this article. There is, however, merit in re-examining share buybacks in our market not to eliminate them but rather to minimise abuse and subversion of true price discovery mechanisms.

To achieve this, in granting approval for share buybacks the ZSE should firstly ensure sound financial performance; past and present. Companies with no history of paying dividends should not be allowed to buy back their shares.

Declaration to the market when actual share buyback trades are done should be introduced. Alerting the market of a company’s intention to buy back its shares eliminates insider advantages and perceptions of price manipulation.

Further, the exchange should, as per its mandate, cause audits of all share buybacks to be done on an annual basis.
Secondly and more importantly, minority shareholders should resist blind endorsement of share buyback resolutions at AGMs by insisting that a detailed analysis of the proposed buyback be carried out by third party financial advisors.

Further, when it comes to voting for the resolution, owner managers should be disqualified from voting.

Our market has a long and proud history and we are all working hard to regain our rightful place as a preferred destination for international capital. Self interest practices such as arbitrary share buybacks should be discouraged. They kill liquidity and keep us in obscurity.

Chinamo is the chief executive of the Securities and Exchange Commission of Zimbabwe.

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