What Goes Around, Comes Around… or is Bought Back

As Adris published last week that they are ready for another big share buyback programme, which ends today, we are bringing you an overview of what share buybacks are, their potential consequences and how much of the total traded volume they accounted for in 2018 in the Croatian and Slovenian market.

Key reasons for a buyback:

  • used to return cash back to its shareholders.
  • the company wants to award their employees and management through stock rewards and option
  • The management deems that the stock is undervalued
  • The management wants to boost the company’s financial ratios (such as EPS)
  • To prevent other shareholders from acquiring more shares (or a takeover)

Percentage of Share Buybacks in Total Traded Volume in 2018 (%)

Source: InterCapital Research

Share Buybacks in the Region

When observing the past couple of years in the Croatian and Slovenian market, one can notice that not many companies were performing share buybacks, at least not on a significant level. In these markets, companies still prefer paying out dividends over buybacks, as a way to return cash back to their shareholders. As visible on the graph above, in 2018, ZABA had the highest percentage of share buybacks in total traded volume, of the observed companies (but note that ZABA’s liquidity is generally lower than many other shown companies). When looking at the Slovenian Market in 2018, Krka was the only company to perform share buybacks.

Contrary to the regional market, in the United States, share buybacks are preferred to dividends. When observing the S&P 500 companies since 2000, they have always returned more to their shareholders through buybacks than through dividends, with the exception of the year 2009. In 2018, more than 60% of the cash returned by S&P 500 companies was done in the form of buybacks.

Turning our attention to Adris, the company published that they are ready for another big share buyback programme. They are targeting up to 1m ordinary shares ADRSRA (10.40% of their total number) and up to 200,000 preferred share ADRSPA (2.95% of their total number). Bids were open from 18 February until today.

Note that in 2018, preferred Adris’ buyback accounted for 40% of the total traded volume.

Shares Bought Back in 2018 Compared to Total Shares Issued (%)

Source: InterCapital Research

What is a share buyback?

A share buyback refers to the repurchasing of the shares by the company that originally issued them.  A buyback occurs when the company, which initially issued the shares, pays their shareholders a market value for the shares and in return gains back the shares that were previously dispersed among investors. Just like dividends, a share buyback can be used to return cash back to its shareholders.

Whether buybacks have a positive effect on the company’s performance has been subject of debate, as there are different views on their causes and consequences.

The Good

When companies are run reasonably, the cash return decision comes as the final step in the process, meaning that the cash that they return to shareholders, through dividends or buybacks, should reflect a residual cash flow. Such buybacks do not have a negative impact on the company, as they are just another way of returning cash to their shareholders, without impacting “good” investments (that make more than their hurdle rate).

Furthermore, buybacks can be helpful in a low liquidity environment. In such an environment, the investors bear the risk of not being able to sell their shares at a given point, as there are not many buyers at every point to buy the shares (at least at the market price). Buybacks can help reduce that risk as they add additional bids. Next, note that share buyback can be more beneficial from a tax perspective for certain investors. Besides that, share buyback is usually a strong signal from the management that the share is undervalued.

The Bad

One negative side of share buybacks is that companies may use them for short term boosts, neglecting the long-term effect. As mentioned above, one of the reasons share buybacks are performed is to improve the company’s financial ratios. When a company performs a buyback, they reduce the number of shares outstanding in the market. This results in an increase in earnings per share, which would (under the assumption that the P/E ratio stays constant) hike the share price up.

The Ugly

Another way buybacks can be negative for the company is when they become the main objective of the company. When this happens, companies generate as much cash as possible to conclude more share buybacks. This means that the companies would, in order to generate cash, be prone to taking more debt, cutting employee wages and not taking on good investment opportunities. In the long run, such behavior could not only adversely affect the company, but also the economy as a whole. Note that such behavior has not been seen in any of the regional companies.

Dino Durrigl
Category : Blog

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