The tech-giant Microsoft undertakes a 40% ‘buyback’ of its shares!- read the recent news headline. Sure everybody has come across it and most of you turned pages of the newspaper or switched sites just after reading the headline, for quite possibly you could not relate to the term ‘buyback’ and its implications, very well. Even I was sailing the same boat, until a friend helped me understand. So let me try the same with you.
Yes it is indeed, as the name suggests ‘buying back’ of shares. But why does a company, in effect, undertake buyback? Well, the BENEFITS TO THE COMPANY from such an act speak for themselves. Let’s have a look.
1. It helps the co. to eliminate threats that may be posed by existing share holders, thus consolidating ownership.
2. It helps the co. fund its stock options (i.e. providing their employees a stake in the co. at reduced rates.
3. The companies are always on alook out of opportunities to invest excess cash, buyback provides them with an option to invest in their own company.
4. Getting to the economic side of it, buying back of the shares would reduce the supply of company’s shares and thus as the free-market demand and supply forces operate, the price of the shares and thus the net worth of the co. as a whole rises.
5. The Earnings Per Share (EPS) of the co. increases; which is perhaps the easiest way out in order to enhance profitability. Even when the earnings are constant and the number of outstanding shares (the amount of shares with the public) reduces, the EPS rises.
6. The company’s goodwill gets enhanced as well, for the buyback benefits not just the co. but the shareholder as well.
BENEFITS TO THE SHAREHOLDER
The company is always interested in increasing their shareholders’ earnings. To a layman, income could well mean any amount of cash (say in the form of dividend earned) coming in. However it is generally believed that companies that reduce the number of shares outstanding instead of distributing dividends regularly fair better. Let’s see why that is so, through an example.
For a person who trades in shares once in a bluemoon paying a tax on the capital gain (gain on sale of shares) might be burdensome and discouraging when compared to someone who trades on a regular basis. Likewise if a shareholder sells his shares in the short run i.e. after holding them for a period of less than a year, he is required to pay a tax of 15% on the capital gain made. Whereas if the shares are held for long term i.e. for a period more than or equal to one year, the shareholder is exempted from paying the tax if a securities transaction tax (STT); which is a negligible amount of per unit tax imposed by the government on every sale or purchase of securities; has been paid by the seller on the securities being traded.
Thus, holding the share stock in the long run is beneficial for the shareholder. The company while undertaking ‘buyback’ takes advantage of this fact. A company woul generally not buyback its shares in the short run, thus when it does so in the long run- the shareholder is benefitted manifold i.e. he has so far earned the dividend declared for the shareholders, gets the share value when the company buys from him and is also exempted from the tax on the gain. Shareholder is happy, and it adds to the goodwill of the company and more people are ready to invest in the company; which is a further gain for the company. The company by undertaking ‘buyback’, thus, fares better.
MICROSOFT buys back! The aftermath…
Recently, the tech-giant Microsoft, soon after having bought Nokia, has undertaken a ‘buyback’ of its shares upto 40% and has joined the league with the other giants as Apple, IBM etc. What could have been the possible reasons for it and the possible implications for the company and the general public? Let’s see what ED thinks could have been the reasons behind such an announcement.
The reason behind the buyback, after having acquired Nokia, could not have been a mere investment purpose or ownership consolidation. However, the profitability and strengthened goodwill that comes along with the buyback could be thought of being the driving forces. Microsoft, over the past 2 years, has lost almost $ 3 billion on its Bing search engine and various other internet projects. Also a $ 6 billion worth of writeoffs for its failed purchase of online advertising agency aQuantive cannot be overlooked. So to make up for the bad image that the public might have formed due to the failing projects could be one reason.
Also now as the shareholders too would have benefitted, more investment is prospective in the company, thus a boost in the share prices is likely to been. The profitability would, thus, be enhanced and it might as well make up for the losses incurred in the past.
Having built up investor interest it might be beneficial for the business to be undertaken by tye company in collaboration with Nokia.
The buyback decision so far seems wise on the part of the company. Let’s see what’s in store for it.
Hope you’ve gathered some useful information. Feel free to share your views with us through the comment box below.