Share Buy-Back

Abstract

Air Asia Bhd is proposing a share buy-back of up to 10% of its issued and paid-up share capital at an up coming EG to stabilize its share price which is recovering from a sell-down. The proposed share buy-back is to stabilize the market price, stop speculation of the shares and enhance investor confidence. “It will enable Airasia and its subsidiaries to utilize any of their surplus financial resources, which is not immediately required for other uses, to purchase its own shares from the market” it said in the filing with Bursa Malaysia yesterday. The budget airline’s share has lost more than half its market value year-to-date. The share price has dropped to 78 sen on Aug 26. It remained under one ringgit for almost two weeks before gaining some ground to end the week’s trading at RM1.31, up 6.5% yesterday. The funding of the proposed share buy-back will be from internally-generated funds, external bank borrowings or combination of both. “All purchased shares may be cancelled or retained as treasury shares or a combination of both. Treasury shares may be distributed as share dividends, resold on Bursa Malaysia Securities and/or subsequently cancelled,” it said in the filing with the stock exchange. The proposed share buy-back will reduce the working capital of the company, the quantum depends on the number and the purchase price or prices. The effect on the group’s net asset will depend on the actual number of and price for the purchased shares, the funding cost, or any loss in interest income to the group, and whether the purchased shares are cancelled, retained as treasury shares, resold on Bursa Securities or distributed as share dividends to shareholders of the company.

Starbizweek, Saturday 19 September 2015

Introduction

Share buy-back is when a company buying back its own shares from the market. The main reasons why public listed companies are buying their shares from the market are when these companies think that their shares were undervalued. Buying of shares will reduce the number of shares in the market. The reduce number of shares in the market will reduce the supply of shares and that this would normally translate into increase of earning per share of the remaining shares in the market.

Legal Provisions

Section 67A of the Companies Act 1965 (“the CA 1965”) provided that its memorandum authorized a public company to purchase its own shares by its article, to purchase its own shares. The intention of section 67A of the CA 1965 was explained by explanatory statement to the Companies (Amendment) Bill 1997:

… to stabilize the supply and demand as well as the price of the shares of the company on the stock exchange and to ultimately create a healthy environment for the capital market in this country.  

However, subsection 2 to section 67A provided that a public company can only repurchase its shares if the company is solvent, the purchase is made through the exchange, and the purchase is made in good faith and in the interests of the company. Noteworthy, the company must be financially solvent before it can proceed to buying their shares from the market. A company is deem to be solvent if it can meet its assets are more than its liability without the company having need to dispose the company’s asset outside the ordinary course of the company’s business.

The law does not allow insolvent company to buy-back their shares from the market because it may be done not at the best interest of the company. Insolvent companies may try to manipulate the price of the shares and this is inconsistent with the intention of the Section 67A of the CA 1967. An insolvent company may exhaust its remaining assets to buy-back their shares, whereas an insolvent company have a duty to preserve its assets to pay off its creditors.  

Upon share buy-back, a company may opt to do the followings:-

i.               cancel the purchased shares;

ii.              retain the shares as treasury shares;

iii.            do both (i) and (ii).

Section 67A provides that once the shares purchased were cancelled, the impact is that the issued capital of the company will diminish. The diminish amount shall be put to the capital redemption reserve. Capital redemption reserve is where the company keep the money when it buy-back its shares and the money cannot be redistributed to the remaining shareholders as dividends.

Treasury shares are Shares issued in the name of the company. The shares are considered issued, but not outstanding. Usually refers to stock that was once traded in the market but has since been repurchased by the company. Treasury shares are not considered when calculating dividends or earnings per share. While in the treasury, all rights attached to the shares are suspended.

Section 67A (3D) provided that:

Where the directors decide to distribute the treasury shares as share dividends, the costs of the shares on the original purchase shall be applied in the reduction of either the share premium account or the funds otherwise available for the distribution as dividends or both.

This section seems to suggest that we are using cost method whereby whenever the shares to be redistributed to the shareholders as dividends, the cost of share buy-back shall be used to deduct the dividend share.

Does share buy-back strategy always work?

The darling of tech industry, Apple Inc. board had embarked on USD80 billion share buy-back. From 2012 until March 2015 alone, Apple has returned over USD112 billion to the shareholders. The company will continue with the share buy-back program and rewarding its shareholders with high dividends policy. Commenting about this policy, the company CEO expresses his confidence that Apple has a bright future ahead.

When a company was blessed with immense wealth, the share buy-back may seems to be a good a strategy. According to the Wall Street Journal in June 19, 2015, share buy-backs “are what all the cool kids are doing.” In was reported in the same article that the first quarter of 2015 saw companies in S&P 500 stock index bought back around USD148 billion of their own shares.

Although in theory, share buy-back will reduce the number of shares and increase the value of the remaining shares, in practical, the share price may also go down. It is also disturbing to note that share buy-back sometimes benefits the board and the management the most rather than the shareholders.

Investing company’s money buying their shares back from the market may give the indication that the company is more interested with the short-term profit rather than investing in the future. However, not all share buy-backs is not good for the long-term growth of company. Company who tender offers to the shareholders, offering the latter to buy back their shares at a stipulated price. This method allows executives to have a firm grip on the ownership of the company and concentrate on the long-term competitiveness of the company (William Lazonick, Profit without Prosperity, Harvard Business Review, September 2014).

Conclusion

Share buy-back can be used as a mechanism to increase the price of the company’s share when the company think that their shares are undervalued by the market. The buy-back is a strategy to increase the value of the remaining shares. However, there is a tendency for companies may lose sight of long-term objectives and focusing on the short-term objective in increasing their share price. It is important for companies to have a clear objective when it wants to exercise the strategy of share buy-back. The key is in striking the balance in reducing the working capital of the company in buying back their own shares and at the same time have the sufficient war chest to invest in future development of the company.