The introduction of share buy-back as a measure to stop the bears that are currently ravaging the Nigerian stock market will not only fast-track the return of the market to the upside, but will  also give better value to shareholders, writes Eromosele Abiodun

Among the several measures outlined by the Federal Government to help the Nigerian capital market from total collapse at the peak of the financial market crisis in 2008 was the concept of share buy-back.

Though new to us in Nigeria, this concept has been in existence in developed markets for ages, a process that has helped quoted companies reduce their shares in issue and create scarcity.

Following the introduction of share buy-back in 2008, the Securities and Exchange Commission (SEC) issued guidelines that would be adopted by companies which wanted to take  its advantage.

However, no company in Nigeria has taken advantage of the policy, apparently because of hindrances in the laws guiding the process.

But in order to encourage companies to implement share-back whenever they deem it necessary, the NSE had to issue its own rules, hoping that the process will finally kick off.

Recently, the Chief Executive Officer of the NSE, Mr. Oscar Onyema, at forum to mark the 50 years of capital market regulation in Nigeria in Abuja, disclosed that the Securities and Exchange Commission (SEC) had approved the rules proposed by the Exchange that would guide the process of share buy-back in the nation’s capital market.

Share buy-back, he added, was being pushed by the NSE as part of its efforts at deepening and enhance liquidity in the market.
Onyema noted that all the plans by the new management of the NSE to transform the Exchange were on course.

Meaning of Share Buy-back
Shares buy-back can be defined as the repurchase of outstanding shares by a company in order to reduce the number of shares on the market. Companies will buy-back shares either to increase the value of shares still available (reducing supply) or to eliminate any threats by shareholders who may be looking for a controlling stake.  You can think of a buyback as a company investing in itself, or using its cash to buy its own shares.

The idea is simple: because a company cannot act as its own shareholder, 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.

Also, buyback is a method for company to invest in itself since they cannot own themselves. Thus, buybacks reduce the number of shares outstanding on the market which increases the proportion of shares the company owns.

How Possible
Buy-backs can be carried out in two ways: Shareholders may be presented with a tender offer whereby they have the option to submit (or tender) a portion or all of their shares within a certain time frame and at a premium to the current market price.

This premium compensates investors for tendering their shares rather than holding on to them. Secondly, companies buy back shares on the open market over an extended period of time.

There are a number of ways in which a company can return wealth to its shareholders. Although stock price appreciation and dividends are the two most common ways of doing this, there are other useful, and often overlooked, ways for companies to share their wealth with investors one of them is share buyback.

Moreover, buy-backs reduce the assets on the balance sheet (remember cash is an asset). As a result, Return on Assets (ROA) actually increases because assets are reduced; Return on Equity (ROE) increases because there is less outstanding equity.
In general, the market views higher  ROA and ROE as Positives.

Suppose a company repurchases 1 million shares at N 15 per share for a total cash outlay of N15 million. If its cash reserve was N20 million before buy-back, it will now be N5 million after buy-back.

Also if its total assets was N50 million, it will now be N35 million after it buy-back its shares. If its Earnings per Share (EPS) was 20 kobo before buy-back, it will now be 22 kobo after buy-back.

But if its earnings was N2 million it will still remain at N2 million after the process. As you can see, the company’s cash hoard has been reduced from N20 million to N5 million. Because cash is an asset, this will lower the total assets of the company from N50 million to N35 million.

This then leads to an increase in its ROA, even though earnings have not changed. Prior to the buyback, its ROA was 4 per cent (N2 million/ N50 million) but after the repurchase, ROA increases to 5.71 per cent (N2 million/N 35 million).
A similar effect can be seen in the EPS number, which increases from N0.20 (N2 million/10million shares) to N0.22 (N2million/9million shares).

Relatively, shares buy-back also helps to improve the company’s Price-Earnings ratio (P/E).

This is because P/E ratio is one of the most well-known and often-used measures of value. At the risk of oversimplification, when it comes to the P/E ratio, the market often thinks lower is better.

Therefore, if we assume that the shares remain at N15, the P/E ratio before the buyback is 75.00 (75 years), after the buyback, the P/E decreases to 68 (N15/ N0.22) due to the reduction in outstanding shares. In other words, fewer shares + same earnings = higher EPS!  Based on the P/E ratio as a measure of value, the company is now less expensive than it was prior to the repurchase despite the fact there was no change in earnings.

As was seen in the above example, a change in the number of outstanding shares can affect key financial measures such as EPS and P/E. In the case of dilution, it has the opposite effect of repurchase: it weakens the financial appearance of the company.

Assume instead, that the shares in the company had increased by one million. In this case, its EPS would have fallen to N0.18 per share from N0.20/share. After years of lucrative stock option programs, a company may feel the need to repurchase shares to avoid or eliminate excessive dilution.

Why Companies Do It
Meanwhile, experts believe that the goal of any good company is to maximise returns for its shareholders.

They added that share buy-back helps to lift markets to positive territory in the long run and give better value to shareholders.

In a chat with THISDAY, Managing Director and Chief Executive Officer of Emerging Capital Limited, Mr. Chidi Agbapu, stated that most company’s management believed that share buy-back is the best use of capital at a particular time.

He said, “After all, the goal of a firm’s management is to maximise return for shareholders, and a buyback generally increases shareholder value. Nevertheless, there are still sound motives that drive companies to repurchase shares.

For example, management many feel the market has discounted its share price too steeply.
“A stock price can be pummelled by the market for many reasons like weaker-than-expected earnings results, an accounting scandal or just a poor overall economic climate. Thus, when a company spends millions of naira buying up its own shares, it says management believes that the market has gone too far in discounting the shares and this is a positive sign that its share will rebound,” he said.

He explained that another reason a company might pursue a buy-back is solely to improve its financial ratios metrics upon which the market seems to be heavily focused.

This motivation, he noted, was questionable adding that if reducing the number of shares is not done in an attempt to create more value for shareholders but rather make financial ratios look better, there is likely to be a problem with the management.

“However, if a company’s motive for initiating a buyback program is sound, the improvement of its financial ratios in the process may just be a by-product of a good corporate decision. Now let me explain how this happens.

First of all, share buybacks reduce the number of shares outstanding. Once a company purchases its shares, it often cancels them or keeps them as treasury shares, and reduces the number of shares outstanding in the process,” he said.

Benefits of Share Buy-back.
On his part, Managing Director and Chief Executive Officer of Cowry Assets Limited, Mr. Johnson Chukwu, believes that the benefits of a company buying back its share far outweigh the disadvantage.

He added that in many ways, a buy-back is similar to a dividend because the company is distributing money to shareholders. He said: “Traditionally, a major advantage that buybacks had over dividends was that they were taxed at the lower capital-gains tax rate, whereas dividends are taxed at ordinary income tax rates.

However, as is so often the case in finance, the question if shares buyback is good or bad, may not have a definitive answer. If a stock is undervalued and a buyback truly represents the best possible investment for a company, the buyback and its effects can be viewed as a positive sign for shareholders.

Watch out, however, if a company is merely using buybacks to prop up ratios, provide short-term relief to an ailing stock price or to get out from under excessive dilution.”

He stressed that one principle investors must know about is that overall growth is not nearly as important as growth per share.
He said, “Too often, you will hear leading financial publications and broadcast talking about the overall growth rate of a company.

While this number is very important in the long run, it is not the all-important factor in deciding how fast your equity in the company will grow. Growth per share is. Let me give you a simple example, if your company is trading at N50 per share and you have 100,000 ordinary shares outstanding with a Market Capitalization of N5,000,000.

“If at the end of this year, the company made a profit of N1 million, each share equals .001 per cent of ownership in the company. (that is,  100 per cent divided by 100,000 shares.). Management will definitely be upset by the company’s performance because it sold the exact same amount of products this year as it did last year.

That means the growth rate is 0 per cent. If the chief executive want to do something to make the shareholders money because of the disappointing performance this year, he can suggests a stock buyback program. If the owners accepts his proposal, the company will use the N1 million profit it made this year to buy stock in itself. So the very next day, the CEO goes and takes the N1 million out of the bank and buys 20,000 shares of stock in his company.

(Remember it is trading at N50  per share (by example above).”
He added that immediately, he took the shares to the board of directors and they vote to destroy them so that they no longer exist.
“This means that now there are only 80,000 shares of your company in existence instead of the original 100,000.

What does that mean to you? Each share you own no longer represents .001 per cent of the company. Instead, it represents .00125 per cent; that’s a 25 per cent increase in value per share. The next day you wake up and find out that your stock  is now worth N62.50 per share instead of N50. Even though the company didn’t grow this year, you still made a twenty five percent increase on your investment.”

Chukwu  also stated that when a company reduced the amount of shares outstanding by declaring a shares buyback programme, each of investors’ shares becomes more valuable and represents a greater percentage of equity in the company.

“If a shareholder-friendly management like the one I use in my analogy above is kept in place, it is possible that someday there may only be five shares of the company, each worth N1 million. When putting together your portfolio, you should seek out businesses that engage in these sorts of pro-shareholder practices and hold on to them as long as the fundamentals remain sound. So, all things being equal, share buyback is a good idea,” he added.

Shareholders’ View
But some representatives of shareholders right group who spoke with THISDAY, disagree on the matter. While some believe that it is a good plan, others said it is not.

National Coordinator, Independent Shareholders Association of Nigeria (ISAN), Mr. Sunny Nwosu, said investors needed time to come to terms with new trends in the capital market.

“Our capital market is an emerging market so you should not be taken aback by what you see, you do not give what you don’t have. For now the knowledge of the average investor to a greater extent in our jurisdiction depends largely on bonus and dividend.
Our market is mainly driven by bonus and dividend, on like what obtains in other jurisdiction. If you have followed the market over time, you will notice that there is a shift from that approach now.

The issue is that the dynamics of the market warrants what you have to do because the capital market is not static. What has happened is that over time the banks have designed a way to manage it (too many shares in issue) which shareholders are fighting about, that is the issue of managing it through share reconstruction and that share reconstruction to a large extent sends investors back to the starting block,” he said.

This, he added, if a company was allowed to buy back its shares in a particular time, its shareholder, the company and the Nigerian economy would benefit.

He added: “You know we started it all. I am glad they are accepting it now. It shows we at ISAN are clearly ahead of others. So what we are saying in essence is that we are evolving, we are emerging and as we continue to do that, people will begin to appreciate these issues. It is because you known it that is why you are saying it, in other words you are selling the knowledge to the people because they don’t know it before now.”

On the other hand, National Chairman,  Progressive Shareholders Association of Nigeria (PSAN), Mr. Boniface Okezie, believe minority shareholders will not benefit from the exercise.
Okezie stressed that the Nigerian capital market was not ripe enough for such intervention.

“In the Nigerian system, a lot of things are still been manipulated, we are not ripe for share buy-back. Where are they going to get the money from, from the share premium account? Most of them control majority of shares in the company, you never can say. They can do it without recourse to shareholders because they are buying back, they will not tell you from which money, either from the shareholders fund or capital reserve. So I am more comfortable with reconstruction that we can see. Your holding was 20 billion ordinary shares and after reconstruction you have 10 billion ordinary shares and at the end of the day they give you better value. Share buy-back for now is not good for our system,” he said.

Source: ThisDay