Podcast | Editor's Pick of the day: All you need to know about L&T's Rs 9000 cr buyback

Did you know Larsen and Toubro was a company started in India by two Danish engineers, Henning Holck-Larsen and Søren Kristian Toubro, who were taking refuge in this country during the Second World War? Well, it’s now an $18 billion multinational company but with roots very much in apna des. And today, the company has announced a share buyback proposal. And that is our story of the day. My name is Rakesh, and you are listening to Moneycontrol.

THE LATEST:

Larsen & Toubro on Thursday approved a buyback proposal of 6 crore shares, amounting to Rs 9,000 crore, at a price of Rs 1,500 apiece. This is a premium of 13.45 percent as of Tuesday’s closing price of Rs 1,322.15. The number of shares make up for 4.9 percent of total paid up equity share capital.

“The buyback is proposed to be made from the shareholders of the Company on a proportionate basis under the tender offer route using the stock exchange mechanism in accordance with the provisions contained in the Regulations and the Companies Act, 2013 and rules made thereunder,” the company said in a filing to the exchanges.

Further the company said that the actual premium would be over the daily average of the closing prices of equity shares of the Company quoted on the National Stock Exchange during the two weeks preceding the date of the Board meeting.

The buyback is subject to approval of the members by means of a special resolution through a postal ballot. The timeline for other processes will be announced later.

In the past one month, the stock has rallied around 6 percent, while in the past three days, it has risen 9 percent.

A M Naik, Group Executive Chairman, told ETNow: “We want to give back to our shareholders. They have been loyal to us. We have been publicly listed from 1951 and we were looking for an opportunity to reward with so much cash lying with us and all the capacity build-up we have done ahead of time for all our future requirements.” He further said that for the next five years, the group has little capital expenditure. “If there is a major acquisition, we have made sure that cash flow is available. So, you must also understand this is our 80th year and it is the right time to reward shareholders. And we had opportunity to reward them and we have done that,” he explained.

L&T had cash and cash equivalents worth Rs 8,700 crore on its balance sheet at the end of the previous financial year.

ANALYST-VIEW:

G Chokkalingam, founder, Equinomics Research and Advisory, said, “L&T is a good stock. Capex cycle is reversing down. I see around 20 per cent upside in L&T stock in another 3 months.”

Global brokerage firm CLSA last week said the buyback will support return on equity (RoE) of the company. “It may not be the last buyback as cash on books stands at $2.1 billion. We maintain ‘buy’ on L&T with a target price of Rs 1,730,” CLSA added.

“In our view, Larsen is looking at a buyback given no large capex plans over next few years, apart from Hyderabad Metro, asset divestments adding to cash balances with the most recent being the Road INVIT in May’18 and E&A segment for Rs 140 billion, low yield on cash which is ROE dilutive and tight control over NWC and resultant improved cash generation,” Motilal Oswal Securities said in a note.

“L&T remains our top pick in the sector – we believe it is an attractive play on a recovery in industrial and infrastructure capex in India. We maintain Buy with an SOTP-based TP of Rs 1,560 (E&C business at 21x FY20E EPS, higher-end of 5-year trading band to which we add Rs 550 for subsidiaries),” it added.

WHAT IS A SHARE BUYBACK?

This year, boards of many IT firms including TCS, HCL Technologies and Mphasis have approved proposals to buy back shares. TCS announced buybacks worth 16000 crore rupees and HCL 40000 crore worth of share buybacks in the last few months.

For the uninitiated among us, what is a share buyback proposal? And why do companies do it?

Investopedia describes share buyback thus:

Stock buybacks refer to the repurchasing of shares of stock by the company that issued them. A buyback occurs when the issuing company pays shareholders the market value per share and re-absorbs that portion of its ownership that was previously distributed among public and private investors. With stock buybacks, aka share buybacks, the company can purchase the stock on the open market or from its shareholders directly. In recent decades, share buybacks have overtaken dividends as a preferred way to return cash to shareholders. Though smaller companies may choose to exercise buybacks, blue-chip companies are much more likely to do so because of the cost involved.

Why would companies do this? There are plenty of reasons. One of the most common reasons cited is ownership consolidation. Let’s say there is a company with one owner and 10,000 shareholders. It effectively means that the company has 10,001 owners. Why do companies issue shares? To raise equity capital to fund expansion. But when a company gets to a point where there are few expansion opportunities in sight, it essentially means holding on to all that equity funding that is not even being used, and sharing ownership for no good reason. Let’s also not forget that shareholders expect dividends which is a cost of equity, meaning the business is paying for the privilege of accessing funds that it is not even using. As Investopedia cited, “Buying back some or all of the outstanding shares can be a simple way to pay off investors and reduce the overall cost of capital. For this reason, Walt Disney (DIS) reduced its number of outstanding shares in the market by buying back 73.8 million shares, collectively valued at $7.5 billion, back in 2016.”

It is a case we see with L&T as well. “L&T’s proposal for a share buyback is a natural fallout of limited investment opportunities in EPC (engineering, procurement and construction), its aversion to investment in long-gestation projects, and strong cash-flow generation in its core E&C business,” said Kotak Institutional Equities said in a 21 August report.

“Consistency of dividend payout through the weak past five-year period and a large quantum of current dividend payout ($350 million) strengthen the case for a structured buyback programme for L&T. The current buyback meaningfully supports L&T’s case for achieving 18% RoE (return on equity) by 2020-21,” the Kotak report added, as reported by Mint.

More so, the company is expected to keep the shareholders happy – by giving dividends. And indeed one of the goals of the company executives is to increase shareholder wealth. And this is where the great balancing act comes. They also need to ensure that the company stays in lithe financial condition should there be a recession. The tightrope walk of ensuring the company stays afloat in tough times while also keeping shareholder wealth increasing is a tough one. One way to do that is by offering share buyback. Per Investopedia, “If the economy slows or falls into recession, the bank might be forced to cut its dividend to preserve cash. The result would undoubtedly lead to a sell-off in the stock. However, if the bank decided to buy back fewer shares, achieving the same preservation of capital as a dividend cut, the stock price would likely take less of a hit. Committing to dividend payouts with steady increases will certainly drive a company's stock higher, but the dividend strategy can be a double-edged sword for a company. In the event of a recession, share buybacks can be decreased more easily than dividends, with a far less negative impact on the stock price.”

Share buyback is also a quick fix for the financial statement. By reducing the number of outstanding shares, a company's earnings per share (EPS) ratio is automatically increased – because its annual earnings are now divided by a lower number of outstanding shares.

One analysis of buybacks is that the company offering it is fiscally healthy and wants none of the excess of equity funding. Even though credit rating agencies don’t often see buybacks in a positive light – as it is essentially taking on more debt – it can also be seen by the market that the management has enough confidence in the company to reinvest in itself. Writer Troy Segal says, “Share buybacks are generally seen as less risky than investing in research and development for a new technology or acquiring a competitor; it's a profitable action, as long as the company continues to grow. Investors typically see share buybacks as a positive sign for appreciation in the future. As a result, share buybacks can lead to a rush of investors buying the stock.”

And that is what we saw on Dalal Street today with regards the L&T stock.

STOCK MARKET RESPONSE TO L&T BUYBACK PROPOSAL:

Shares of Larsen & Toubro Ltd on Thursday closed over 2% higher after its board approved a share buyback of 9,000 crore, at a premium of more than 13% from Tuesday’s closing price. L&T shares ended at Rs 1,352.50 on the BSE, up 2.3% from their previous close, while India’s benchmark Sensex Index rose 0.13% to 38,336.76 points. Year to date, L&T has risen 7.6%.

Share buybacks can be good for the financial economy as they lead to a rise in stock prices. Research has shown that increases in the stock market have an ameliorative effect on consumer confidence, consumption and major purchases, a phenomenon known as "the wealth effect."