Understandably, listed companies held on to their cash in 2020 to be in the best position to adapt to the challenges and uncertainties of the pandemic. Fast forward to 2021 and many who have weathered the storm are coming out the other side with strong balance sheets and a commitment to return cash to shareholders.
Therefore it comes as no surprise that the transaction value for share buybacks announced in Q1 2021 is 1.5 times larger than the whole of 2020. Before embarking on any share buyback programme there are six questions an issuer should consider.
1. Is this the right thing to be doing with our money?
In recent years share buybacks have been criticised as the “height of short-termism” on the basis that companies should look to reinvest surplus cash into the business for long term gains rather than returning it to shareholders. Share buybacks can also be met with scepticism as they naturally increase earnings per share (by decreasing the number of shares in the market), which is often used as a benchmark for executive share plans. Another drawback of an on-market share buyback is the perception that, unless you launch a full tender offer with a circular to all shareholders, only institutional investors will participate – whereas if a special dividend were to be paid instead, retail shareholders would benefit equally. In light of this, companies need to be prepared to address difficult questions as to why a share buyback is the right course of action.
2. How many shares should we buy?
Companies typically seek shareholder authority at each AGM to purchase up to 10-15% of their shares. Any buyback programme will need to be conducted within the parameters set by that shareholder authority. In practice the company will decide the target level of cash to be returned to shareholders and will instruct brokers to buy shares at or close to the market price (subject to the price limits set out in the shareholder resolution) until the target is met.
3. Do we have reserves in the right place?
The purchase price for the shares must come from distributable reserves, and these will need to be available at the level of the parent company. Where distributable reserves are only available in operating subsidiaries lower down the structure, these will need to paid up to the parent, which will need to prepare and file interim accounts showing enough distributable reserves to fund the repurchases.
4. What additional costs will there be?
As well as the purchase price there will be stamp duty at 0.5%, legal fees and broker fees. Broker fees are usually based on a fixed percentage of the purchase price. They often include an additional element which will incentivise the broker to achieve the best possible price for the shares. This is usually done by reference to the volume weighted average price (VWAP) over the life of the programme.
5. What will we do with the shares we buy back?
Companies can cancel the shares bought back or hold them as treasury shares. Treasury shares can be transferred for the purposes of an employees’ share scheme or sold for cash. Many companies choose to hold repurchased shares in treasury as it gives them additional flexibility for the future
6. When will we do this?
The optimum timing for any share buyback programme will need to fit with the company’s other strategic plans, such as proposed M&A. There are also certain windows in a company’s financial calendar when a buyback can be launched.
Often companies will choose to announce their intention to carry out a buyback programme alongside their preliminary or interim results.
A company cannot buy its own shares during close periods or when it has inside information unless it has appointed a broker to carry out the programme on its behalf. Therefore it is usual for the company to appoint a broker who will conduct the programme within the agreed parameters without further instruction from the company. This engagement letter must be signed at a time when it has no inside information (eg not at a time when it is delaying disclosure of inside information about a transaction under negotiation) and is not in a closed period.