Enhancing value--buyback of shares

Priya Kansara / Mumbai April 14, 2008

A host of companies have announced share buyback plans to improve shareholder value. The Smart Investor takes a look at these offers and what they mean for companies and their shareholders.

While the markets may seem trapped in a quagmire after tanking nearly 25 per cent since the peak in mid-January, many stocks have lost as much as 50 per cent of their values during this period.

Participation from investors, large or small, domestic or foreign, has also reduced substantially. Thus, considering the grim scenario, a large number of companies, irrespective of their scale or size, have announced buybacks since the beginning of 2008.

While the biggest motive is to support their respective stock price and avoid hostile takeovers, another reason could be to pep up shareholder sentiments and utilise the surplus cash or investments. The current trend is perhaps more to do with the downturn in Indian markets, which have made valuations attractive.

That apart, foreign parents of Indian subsidiaries like ICI India or Hindustan Unilever may want to enhance their stakes beyond the usual 51 per cent. A buyback generally reduces the company's surplus cash but it also reduces the equity base thereby leading to an increase in future earnings per share and improvement in return ratios.

While many of them have their buyback offers open currently, more companies seem to be joining the list.

The most recent announcements have come from Aurobindo Pharmaceuticals, Banco Products and Sasken Communications. To know more on the offers and what it means for the company and its shareholders, read on.

Great Offshore Great Offshore, the leading oil services provider, recently approved the buyback of shares. While the company's cash balance of Rs 57 crore as on March 2007 is not huge and neither significant to make an impact on its share price, funding the buyback should not be an issue.

While the buyback amount of Rs 54 crore is about a fourth of its estimated annual net profit of Rs 217 crore for FY08, what is of concern though is the company's high gearing at 1.2 times as on March 2007.

The company had raised $42 million in October last year by way of FCCBs (due 2012), which is convertible into equity at Rs 875 per share. However, the robust long-term outlook for company's cash flows on account of its improving financials amid strong industry scenario should improve its debt servicing.

There has been a worldwide shortage of rigs, while on the other hand the demand for energy is rising faster than supply.

Consequently, the charter rates for rigs have increased by about 200 per cent over the past three years. This is expected to continue in the coming years as well. In the Indian context, there are investments of over $8 billion lined up for exploration activities.

Great Offshore is at an advantageous position as it is one of the leaders and the only integrated offshore services provider in India. The company offers a wide range of services such as offshore drilling, offshore logistics support, marine construction and port and terminal support to oil exploration and production (E&P) companies in India as well as abroad.

The company is further expanding its operations through organic and inorganic route. It has placed orders for a jack-up rig and a multipurpose support vessel (MSV) for $160 million and $65 million with Bharati Shipyard, expected to be delivered by January 2009 and June 2009 respectively.

It is also set to take a controlling stake (90 per cent) in SeaDragon Offshore, a UK-based offshore drilling company, for close to $1.4 billion.

SeaDragon is constructing two sixth generation, deepwater, harsh environment semi-submersible drilling rigs capable of drilling up to 10,000 ft. These are expected to be delivered by Q4 CY09 and September 2010 respectively. These initiatives are expected to keep its financials buoyant.

The stock trades at an attractive 11 times and 7.5 times its estimated price to earnings multiple for FY09 and FY10 respectively. Prospective investors can consider entering the stock at the current levels and existing investors can hold on.     CASH FOR SHARES Rs crore Buyback Amount Maximum  price (Rs/share) Date of Total debt to equity (x) Cash &  Investments Latest market capitalisation Commencement Closure Reliance Energy 800 1,600 25th March, 2008 4th March 2009 0.70 7,449 27,837 Hindustan Unilever #* 630 230 3rd October, 2007 Closed 0.07 1,692 53,980 ICI India* 211 575 10th August, 2007 11th July 2008 0.00 831 2,204 Great Offshore* 55 750 Proposed - 1.21 58 2,370 Patni Computer #* 237 325 14th April 2008 6th February 2009 0.00 1,276 3,400 Madras Cement^ 64 4,200 29th Feb, 2008 Closed 1.02 145 3,877 GTL* 259 300 29th October 2007 Closed 0.76 1,348 2,642 Aurobindo Pharma - - Proposed - 2.35 583 1,652 Mastek *$ 65 750 Approved - 0.00 151 921 ^ Buyback offer was initially expected to close on 30-January-2009  * consolidated, # Calendar year(2007), $ June ending  Total debt to equity, cash & investments are FY07 numbers Source: BSE/ Capitaline

ICI India The share price of ICI India jumped over 20 per cent between March 24 and 31, thanks to the company's decision to sell its adhesive business. ICI India is now a 53.88 per cent subsidiary of Akzo Nobel, following the latter's takeover of UK-based parent ICI plc this January.

As a part of the strategy, its new parent (Akzo Nobel) wants to ramp up ICI's paint business and divest other businesses, which led to the sale of the global adhesive and the electronic material businesses of ICI plc to Henkel for 2.7 billion pounds.

As a result, ICI India's adhesives business is also being sold to an Indian affiliate of the Henkel Group, for about Rs 260 crore and the process is expected to be completed by December 2008.

This, along with the sale of its various non-core businesses in the past, is expected to balloon its investment kitty to over Rs 1,000 crore (Rs 275 per share)-almost equivalent to 50 per cent of its current market capitalisation.

Going forward, ICI India is expected to benefit from the good prospects for the paint industry, greater synergies following concerted efforts of Akzo Nobel in growing ICI India's business, access to a wider portfolio of products of its new parent, its increased focus on premium products and a huge pile of cash (roughly about Rs 880 crore even after the buyback), which can be used for organic and inorganic growth opportunities.

Notably, the paints business enjoys a healthy return on capital employed of over 20 per cent. The stock trades at about 18 times its estimated price to earnings (excluding cash) multiple for FY09. Long-term investors should hold on to the stock and prospective investors may accumulate the stock on declines.    ROBUST FUTURE Rs crore Net sales     Net profit EPS (Rs) P/E (x) FY09E FY09E CAGR (%) FY09E CAGR (%) FY09E CAGR (%) Reliance Energy 7,237 12.6 1,108 17.6 47.4 13.2 24.8 Hindustan Unilever# * 17,791 13.1 2,408 12.1 10.7 11.5 22.8 ICI India* 1,027 0.7 118 19.0 31.6 21.5 18.1 Great Offshore* 875 22.7 240 28.4 56.0 21.4 11.1 Patni Computer*# 3,374 12.0 461 -2.4 32.0 -4.4 7.7 Madras Cement 2,802 33.4 610 40.7 505.5 40.8 6.3 GTL* 2,233 55.3 204 74.0 21.0 74.5 12.4 Aurobindo Pharma 3,144 21.7 299 21.9 37.0 -1.3 8.3 Mastek*$ 1,038 14.3 133 11.6 46.5 20.5 6.9 * consolidated ,# Calendar year (2007), $ June ending, CAGR: between FY07-FY09E,      Source: Analysts Reports

Mastek The Mastek board had approved the buyback of the company's shares worth Rs 65 crore at a price not exceeding Rs 750 per share in October 2007.

While there is no update on the buyback offer, the stock has largely moved in line with the BSE Sensex and has also outperformed the BSE IT index since the announcement.

Mastek, a software solutions and integration services provider, is among the top-20 IT software and service exporters from India.

The company provides enterprise solutions to insurance, government, and financial services organisations worldwide. Mastek has a differentiated position in its insurance practice with its well-adopted solution framework–Elixir.

With its principal offshore delivery facility based at Mumbai, Mastek operates across the US, Europe, Japan, and Asia Pacific regions. Given the increased traction in the insurance vertical, and Mastek's efforts to establish tie-ups with large BPO companies, Elixir can boost growth and margins.

Mastek reported strong growth in the March 2008 quarter, which was ahead of estimates. Net sales grew 10 per cent q-o-q to Rs 230 crore, accompanied by an expansion of 200 basis points in operating margins to 19.3 per cent, compared with December 2007 quarter.

This along with a higher other income led to a 29 per cent q-o-q jump in net profit to Rs 35.1 crore. Analysts are confident about the strong growth prospects in the coming years.

Patni Computer Patni Computer is already one of the cheapest stocks available in the IT space. While the stock has underperformed the BSE IT index, the recent meltdown has only made its valuations more attractive.

The situation may change though in the near-term considering the maximum buyback price of Rs 325, which is at a 35 per cent premium to the current market price of Rs 240. Also, since the promoters hold nearly 58 per cent stake, this gap could narrow soon.

Patni still has a very high exposure to the US market, which contributed 78 per cent to its revenues, even though it is making efforts to increase the share of Europe, Japan and Asia-Pacific. Thus, till such time, the US financial crisis and the slowdown in the banking and financial services segment–its key market, is likely to keep its revenue growth subdued.

On the other hand, higher wage costs and attrition along with lack of direction on the currency front poses a grim outlook about the company prospects. It reported a sluggish financial performance in Q4CY07 as well, with revenues growing 1.9 per cent q-o-q to Rs 686 crore and net profit declining by 9.2 per cent q-o-q to Rs 99.7 crore due to lower foreign exchange gains.

The guidance given by Patni for Q1 CY08 is also muted, wherein the company reported 0.5 per cent to one per cent q-o-q revenue growth to $175-176 million, and lower net profit (without forex gains) of $15.5-16 million, as against $25.3 million.

In this light and amid the cautious view for IT stocks, investors can hence take advantage of the situation and exit at higher levels, as and when the stock rises.

Reliance Energy The buyback announced by Reliance Energy, to be rechristened as Reliance Infrastructure, worth Rs 800 crore is the biggest buyback amount announced till date since the beginning of 2007.

The company has already bought shares worth Rs 250 crore since the buyback began on March 25. The buyback is unlikely to impact its financials in a big way.

Consider this: the company had cash and investment balance worth Rs 7,500 crore as on March 2007. In the nine months ended December 2007, the company reported a net profit of Rs 773 crore, which was up by 37 per cent y-o-y.

In addition to this, it recently issued 4.3 crore warrants to promoters amounting to Rs 7,834 crore, convertible into shares at a price of Rs 1,822 by July 2009. It also plans to raise Rs 5,000 crore through an international issue of securities.

Further, the company is likely to report healthy growth in the coming years due to its strong position in the Indian power sector and its emerging presence in the infrastructure business.

Moreover, it will also gain due to its 50 per cent stake in Reliance Power, which is expected to reap the benefits of its mega investments after three years. The Reliance Energy stock price, which has been battered heavily on the market and has halved since its peak in mid-January 2008, should find some support due to the buyback scheme.

However, even now its stock price look stretched factoring in much of the future growth prospects. Existing shareholders will be better off holding the stock, while new investors could buy on declines.