Just like renovating your house can make it more attractive, capital restructuring makes companies attractive to potential stakeholders, reduces costs, increases efficiency, increases EPS and gives better returns.
Companies, like individuals, never stop evolving. Competitive pressures, shareholders' demands, management decisions and regulatory and political environment, all warrant that companies keep on reinventing themselves and adapt to change. Operational, managerial and financial dimensions may therefore, often be subject to restructuring. Approaches of restructuring that a company may adopt include expansion, sell-offs, corporate control, and changes in ownership structure.
Share repurchase or buy-back is one of the most important strategies that a firm uses to restructure by changing its ownership structure. A company can use the share repurchase route when it has excess cash. The excess cash therefore, can be made to work on a better investment. The company can also buy back its shares from the market to thwart a hostile takeover bid. A buy-back also generally results in an increase in the EPS because the number of outstanding shares reduces.
Share repurchases or buy back may provide many benefits to companies. Share repurchases are one-time returns of cash. Rather than paying dividends companies can utilise excess cash to buy-back their shares. Repurchase may offer tax buffer to stockholders, because the stockholders' gains will be taxed at capital gains rate, which is usually lower than the ordinary income tax rate. Apart from these, share buy-backs can be affected in a short time facilitating fast capital restructuring. Historical data also shows that markets perceive share repurchase as a positive signal.
However, on the flip side it is possible that repurchase of shares might send negative signals; because the market might think that the company has no profitable ventures to invest in. Since repurchases erode cash resources, the company might also lose on growth opportunities. Lastly, if the repurchase decision is mismanaged, the company could risk insolvency.
The shares that companies wish to buy back are the outstanding shares of the common stock. They might be with the common investors or might be in the possession of some large investors. The firm usually offers a premium to shareholders above the market price of the share while repurchasing them. What are the methods that a firm can employ?
The buy-back methods include repurchase tender offer, open market purchases, and privately negotiated repurchases. The firm might issue a cash tender offer in the open market to repurchase its shares. The tender offer usually sets forth the number of shares that the company wishes to repurchase as well as the price at which it will repurchase the shares. The tender offer is also a time-bound offer and states the period for which the offer would be extended. Tender offers are mostly used for large equity repurchases.
In developed markets open market repurchases occur more often than tender offers because they are much cheaper to administer. Open market purchases can also be spread over longer time periods than tender offers. Open market purchases offers are most often used for small equity repurchases.
Negotiated purchases might be used to thwart the actions of a raiding company, which is trying to mop the shares of the target company from the market. Negotiated purchases involve a small number of investors who hold significant chunks of a firm's shares.
Besides being a strictly financial decision, share buy-back is also an information signal to the market. For example, if the firm offers to buy-back its shares at a very high premium, it might send a signal that the firm believes that its stock is undervalued. The decision to go for share buy-back or invest the spare cash in other activities is a tough one. Usually, managers and shareholders have different views on the issue. However, the management-shareholder conflict can be resolved when there are large shareholders who can monitor and discipline the management.
Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.