Friday, January 13, 2012

Share Buy-backs in 2011 - Legal Framework, Reasons, Criticism, and Parameters

2011 has been a year of numerous share buy-backs.

Some major examples of last year’s buy-back transactions are shown below:



Legal Framework

The legal framework of such operations depends on the legal form of the company (public limited company, limited liability company, etc.), the publicly or privately held status of the company, and the purpose of the buy-back and its legality under local legislation.

For example, French listed corporations can operate share buy-backs under the following simplified conditions:



Reasons for share buy-backs in 2011

As reported by the FT, the companies’ rationales for share buy-backs in 2011 were

  • Lack of M&A opportunities
  • Cheap debt (bond yields and interest rates) to finance buy-backs
  • Low stock markets in 2011
  • Boost the company's stock price
  • Increase earnings per share

Criticism of share buy-backs

Five main critiques raised against share buy-backs.

First of all, it is held that shareholders are not treated equally as is the case for special dividends. Especially, most investors appreciate a steady and predictable dividend growth and, hence, will prefer companies conserve heir cash for longer-term value creation such as investments and acquisitions.

Second, companies tend to operate share buy-backs when they have excess cash rather than when their stock prices are low.

Third, when share buy-backs are carried out when the share is undervalued, cash might be distributed at the wrong time because in times of low share price, capital might especially be needed.

Fourth, bond- and other debt-holders are left out in case of a share buy-back.

Finally, share buy-backs signal a lack of desire to invest in the business.

Parameters for a share buy-backs

When planning for a share buy-back, management should take into account the following parameters:

  • Cash needs
  • Strategic uses of cash (= right balance between returning cash to shareholders and keeping the financial flexibility for the business)
  • Market and environment changes
  • Chosen capital structure
  • Targeted rating and potential rating downgrade due to reduced creditworthiness.

Example of a share buy-back - Bouygues






Bouygues cited the below grounds for its buy-back offering:

  • Massive fall of the share price
  • Selling shareholders are offered a 30 % premium whereas remaining shareholders will benefit from approximately 11 % increase on EPS.
  • The company’s financial structure will be preserved.
  • Self-financing capacity covers working capital requirement fluctuations.
  • Employment policy, strategy, and dividends’ policy remain unaffected.

S&P’s rating downgrade was justified by

  • Impairment of credit ratios
  • Heavy capital expenditures to come in 2012
  • Reduced predictability of financial policy.

Further Reading

Please read my FT clipping list “Share Buy-backs” at http://clippings.ft.com/lists/share-buy-backs for more details on the above.

The documentation related to Bouygues’ share buy-back can be found at

http://www.bouygues.com/en/finance-shareholders/analysts-and-investors/investors-presentations/investors-presentations/
and
www.amf-france.org.