What are the nuances of the Infosys buyback offer?
The Infosys buyback announcement came around the time there was a major top level churn going on at the company. The buyback had already been announced but the finer points of the buyback proposal were awaiting approval which came in last week from SEBI. Unlike the other buybacks of TCS, Wipro and HCL Tech, the buyback of Infosys is much more complex. The Infosys stock is listed in the US, the UK, France and India necessitating multiple approvals. Also, Infosys has over 50% of its shares held by foreign investors which include a large chunk of ADR holders. The Infosys buyback also includes an offer to buy back for the ADR holders. These ADRs will have to be converted into domestic shares through a special window before they can apply for the buyback. But, first the logic of the buyback offer!
Why has Infosys come out with a buyback announcement?
The trigger for a buyback came from Cognizant which announced a $3.4 billion buyback earlier this year under pressure from its institutional shareholder, Elliott Funds Management. The Infosys management under Vishal Sikka also came under pressure from the founders and the institutional shareholders of Infosys to distribute a generous dividend or return money to shareholders through a buyback. Globally, it is quite common for companies with a large cash pile and with limited investment opportunities to seriously consider buyback proposals. Infosys is sitting on a cash pile of $5 billion and thus was a natural candidate for a buyback. Also, a buyback made more sense from a taxation perspective as compared to a special dividend. In the 2016 Union Budget, the government had imposed an additional 10% tax on dividends in the hands of the shareholders. A buyback has no such implication and hence would be more tax efficient compared to a special dividend. Above all, a buyback reduces the number of shares outstanding and therefore improves the EPS of the company. At least, theoretically, that can be value accretive for the company!
Source: Bloomberg
As the chart above depicts, Infosys stock has given the lowest returns in the last five years and, in a way, this buyback is expected to arrest this slide.
Coming down to the specifics of the Infosys buyback announcement
Under the buyback scheme, the company proposes to buy back 11.3 crore shares at a price of Rs.1150/- each which will take the total size of the buyback to Rs.13,000 crore ($2 billion approx). Remember, this still leaves the company with a cash pile of $3 billion after the buyback. This is the total size of the buyback including individual, corporate and institutional shareholders. Remember, this includes the global shares that are held in the form of ADRs too.
However, SEBI has already stipulated that 15% of any buyback offer must be reserved for retail investors. This works out to a retail investor allocation of 1.7 crore shares out of the total. A retail investor here has the same definition as in the case of an IPO which implies a value cut-off of up to Rs.2 lakh. However, since the record date is not yet announced it is not clear what cut-off price will be considered. This cut-off price will play a critical role in deciding the acceptance ratio (the ratio of your holdings that will be eligible for buyback) in the process.
Understanding acceptance ratio in the Infosys buyback with price simulation
As stated earlier, since the record date for the buyback is yet to be announced, we will have to make some reasonable assumptions pertaining to the likely buyback price. Let us, for the sake argument assume that the buyback price gets fixed at Rs.925/share. The table below captures the status of buyback for retail shareholders
Indicative price fixed for buyback for sharesRs.925/-Number of shares held to qualify for retailUp to 216 shares (200,000/925)No. of shares held by small shareholders3.38 crore (As per company filings)Acceptance ratio for retail shareholders50% (1.7 cr. shares allotted/3.38 cr. shares total)Number of shares that will be accepted108 shares (216 shares X 50%)
Let us take the case of a retail investor who holds 216 shares (for the sake of simplicity) in Infosys. Out of 216 shares, 108 shares (50%) at a buyback cut-off of Rs.925 will be eligible for buyback at a price of Rs.1150/-share. Effectively, this gives him a premium of Rs.225 (1150-925) over the market price. Since the acceptance ratio is 50%, the Rs.225 premium that he gets on the buyback shares will reduce the breakeven of his balance holdings by a similar amount. As a result, the balance 108 shares that the investor is still holding will now have a breakeven of just Rs.700 (Rs.925-225). That gives a huge margin of safety to small investors to hold on to the shares with a low level of risk.
Of course, a lot will eventually depend on the buyback price that is determined. For retail investors, the big takeaway is that the combination of assured quota and an attractive price will end up reducing their break-even price substantially. Now for the cut-off price!