The board of IT services firm Mindtree will meet on Tuesday to discuss a share buyback proposal.
The founders of Mindtree, who together own 13.32 percent in the company, are trying to fend off a Rs 10,800-crore hostile takeover bid from
L&T, India’s largest engineering company, by buying back shares from public shareholders.
Let's understand how a share buyback proposal can help avert the hostile takeover of the software firm.
What are share buybacks?
Share buyback involves repurchasing of the company's shares that were issued earlier. The buyback is when the company pays the shareholders the market value per share and re-absorbs the portion of its ownership that had been sold to the public. The company can buy the shares in the open market or directly from the shareholders.
If Mindtree buys back its own shares from the shareholders, its stake in the company will increase and will prevent L&T from owning a majority stake in the IT firm.
However, if the deal between VG Siddhartha and L&T is approved, the stake of L&T will increase to around 66 percent in Mindtree.
Why is it a positive move for the companies?
The move helps the company to consolidate its ownership and boost key financial ratios by using up the unused cash (or shares), preserving the share price and uplifting the assets.
How will the move help investors?
Generally, share buybacks overtake dividends as a preferred way to return cash to shareholders. When the company uses cash to buy company shares, the investors get a chance to defer capital gains if share prices increase and many a time, the share price of the company shoots up at the time of the buyback. Apart from the immediate impact, buybacks also help in reassuring investors and potential investors, the credibility of the company.
Yes, buybacks have their own share of cons. If the company has to borrow money to initiate the share buyback, the company's credit rating is at the risk of getting downgraded. Many firms also finance these buybacks because the loan interest is tax-deductible, which could risk its credibility.
Are there any cons of a buyback?