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IT companies: Bunch of Buybacks

Mar 06, 2017(14:14)
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India is the world largest outsourcing destination for the Information Technology (IT) with global market share of 67%. The industry has created employment for about 10 Mn people globally. This strong capacity of creating employment has generated significant demand in the education sector especially for engineering and computer science. India cost competitiveness in providing IT services is much cheaper than the US, so with the low cost and effective work force the industry was able to attract many large clients or companies for IT services. For the past two decades, the industry has witnessed both creamy and tough edges and continuing its growth momentum further. During this period of past two decades, IT industry has created enormous wealth for investors.

Currently, IT industry is experiencing challenges relating to global headwinds which are affecting shareholders return. At this juncture of slowdown, there is an increased pressure on IT companies to return cash to shareholders in the form of buybacks. Other reason for increased pressure for buybacks is that none of the major IT companies have ventured into any large acquisition or takeovers. In that context, Indian giant IT companies are being convinced to go for buybacks to return some of their ample cash reserves. With the cash availability of Rs. 38,000 cr as on Dec, 31 2016, TCS has announced India biggest share buyback of Rs. 16,000 cr with a plan to repurchase 5.61 cr equity shares at Rs. 2850 per share through tender route. This will be the biggest buyback ever in the Indian capital market against Reliance Industries buyback offer worth Rs.10,440 cr which was carried out in 2013.

IT industry leads the pack globally:

A trend of buybacks is emerging among Indian IT companies recently; however, the large global tech companies like Apple, Microsoft, Intel, Oracle, HP and Yahoo have undergone buybacks before, indicating that IT industry leads the pack globally in comparison to the other industries. Earlier this month, Cognizant announced that board has approved a plan to return $3.4 Billion to shareholders over the next two years through a combination of share repurchase and dividend. The major reason is that the IT companies are sitting on large chunk of cash; and the companies have no immediate plans of any major capacity expansions or acquisitions.

More with challenges; Facing global headwinds:

Indian IT companies dependent on geographies like America, UK and Europe, which means anything relating to currency fluctuation, any impending changes in the country administration, further issues with Brexit which was announced last year and the recent announcement about H1B visa will pressurise the business in IT industry. For an instance, in FY16, the management of Infosys pointed the growth guidance of 13-14% per year. Then the company cut its FY17E revenue guidance to 8-9%. Another longer-term challenge and opportunity for the sector was automation. India IT industry has created millions of jobs till now and IT industry became the core of opportunities. The companies believe that the transformation towards automation, robotics or Artificial Intelligence (AI) improves productivity, as the shift adds to efficiency and drives down hiring rates.

Few more companies were expected to join the queue:

Apart from TCS and Cognizant, on 31st Jan 2017 Mphasis board has also approved Rs. 1,103 cr buyback plan representing 1.73 cr equity shares which is 8.6% of total paid-up shares. TV Mohandas Pai, Former CFO of Infosys, is one of the strong advocates that the time has come for Infosys to start looking for buybacks and increase Earnings Per Share (EPS) using the surplus cash. Infosys has liquid assets worth of Rs. 35,697 cr on its books, and has been under pressure from investors to utilise the amount either through share buyback or distributing dividend. The news which was rolling around another giant is that HCL also planning to repurchase its own shares, however there was no formal announcement made by the management until now. In June 2016, Wipro had also undergone through the buyback by repurchasing 4 cr shares at a premium of Rs 625 per share at a value of Rs 2500 cr.

Impact on earnings and return ratios:

Recently, IT companies witnessing single digit growth rate which was not expected by the investors leading to low shareholder return. So, by the event of buyback, the value of the stock can be arrested by reducing the supply of the stock. In this way, the company can able to improve its EPS which displays the optimism of company management indicating that the company shares are under-valued. Further, it will also affect return ratios like RoE, RoCE where the ratio will move up as the share capital become lower.

Conclusion:

So, overall, buyback will not involve any risk if companies have abundant cash. It is also a tool to boost earnings per share, however currently the industry is facing tough time relating to global headwinds. Altogether in a growth challenged environment, the announcement regarding buybacks will increase the shareholders returns; however, one section of market may also assume that the company is undertaking these exercise as there is no further growth opportunity in terms of business. So, managements need to balance these expectations in terms of effective distribution of cash to shareholders; and at the same time, they have to keep enough resources ready for future expansion / acquisition opportunities. 

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