Understanding why companies decide to purchase its own share

Introduction

Laymen explanation

If you have heard of Dell stock repurchase happened last year, you might be questioning why the company wanted to purchase its all shares and wanted to become private. Also, you might be curious to know if Dell is the only company which did so. In fact, many other companies regularly purchases its own share. Curious to know why? This article helps to understand this.

Technical explanation

A stock buyback, also known as a "share repurchase", is a company's buying back its shares from the marketplace. You can think of a buyback as a company investing in itself, or using its cash to buy its own shares.

Reason of buyback

• Repurchased shares are absorbed by the company, and the number of outstanding shares on the market is reduced. When this happens, the relative ownership stake of each investor increases because there are fewer shares, or claims, on the earnings of the company.

• If the goal of a firm's management is to maximize return for shareholders and a buyback generally increases shareholder value.

• Sometime company's strategic long term vision needs tough decision which can impact financial result in short term. In this case, company wants to be private and absorb this impact on his own. For this, it will buyback all stocks

• A company may move forward with a buyback is to reduce the dilution that is often caused by generous employee stock option plans (ESOP).

• Management may feel the market has discounted its share price too steeply. The buyback also helps to improve the company's price-earnings ratio (P/E). The P/E ratio is one of the most well-known and often-used measures of value.

Suppose a company repurchases one million shares at $15 per share for a total cash outlay of $15 million. Below are the components of the ROA and earnings per share (EPS) calculations and how they change as a result of the buyback.

Buyback approach

Tender Offer

Shareholders may be presented with a tender offer by the company to submit, or tender, a portion or all of their shares within a certain time frame.

The tender offer will stipulate both the number of shares the company is looking to repurchase and the price range they are willing to pay (almost always at a premium to the market price). When investors take up the offer, they will state the number of shares they want to tender along with the price they are willing to accept. Once the company has received all of the offers, it will find the right mix to buy the shares at the lowest cost.

Open Market

The second alternative a company has is to buy shares on the open market, just like an individual investor would, at the market price. It is important to note, however, that when a company announces a buyback it is usually perceived by the market as a positive thing, which often causes the share price to shoot up .

More than 95% of the buyback programs worldwide are through an open-market method,^[4]

Does companies always fulfil its intention of buyback

Companies can announce repurchases and then fail to complete them.[1] Repurchase completion rates increased after companies were required to retroactively disclose their repurchase activity, the result of an effort to reduce the perceived or potential exploitation of public investors.[1]

Reference

https://www.investopedia.com/articles/02/041702.asp

https://en.wikipedia.org/wiki/Share_repurchase

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