Monday, May 05, 2008

Boys cancel capital; Men own treasury stock

Not too sure whether I could stomach this. Share buybacks in India totaled $1.1 billion from nine deals so far this year. True spunk in times of inflation, crude price spiral and liquidity concerns. Boards must be having wholesome breakfasts I guess :)

Besides the recently concluded Madras Cements buyback, the others that have been lined up are of Reliance Energy, Great Offshore, Mastek, Patni Computer, Gujarat Flurochemicals, JB Chemicals, Sasken Communication and Goldiam International.

But I wonder why Indian laws mandate "cancellation" of shares bought back. Is earnings beef-up (because lesser no. of shares now stake a claim to enterprise earnings) the only motive? I think that's a very myopic outlook because you are compromising on long term resources. It betrays a lack of enterprise long term vision. Is there a guarantee that the company could raise capital in future at a lesser cost than the portion that got canceled? What about time taken to raise it? Will opportunities wait till you raise capital? Enterprise is all about sudden opportunities. Capital adequacy helps swift exploitation of an opportunity. The shareholders (both existing and those cashing out) may be enriched in the short term but they are also giving up quite a bit of future capital productivity.

So why can’t companies be allowed to hold at least a part of capital bought back as Treasury stock in their balance sheet?

The significant advantage could be that treasury shares have the potential to restore the distributable profits used when shares are bought back. The distributable profits used to buy back shares are lost when the shares are cancelled. Purchases into treasury still count as a reduction in shareholders' funds but, on the sale of shares out of treasury, the sale price will replenish the distributable reserves up to the amount lost on their acquisition. Any profit made by the company on a sale of treasury shares must be credited to the share premium account. This ability to recreate distributable profits, not available on a share buyback and cancellation, means that it is likely that shares bought back in future will be held in treasury up to the permitted levels.

Just as in the laws of UK, allow it with some restrictions –

- seek shareholder approval

- prevent companies from buying shares into treasury during close periods or when they are in possession of unpublished price-sensitive information, other than in certain limited circumstances;

- express ban for insiders to buy or sell stocks from or into treasury portfolio;

- prescribe ceilings based on net worth

- treasury stocks are denied the right to vote, dividends but are entitled to bonus shares;

Another benefit from treasury holdings is that these shares can be later applied towards employee stock options to reward talent. In the U.K., transfer out of treasury stock towards Employee stock option programs are exempt from stamp duty unlike employee stock option trusts where the company has to bear the trustee fee besides bearing the burden of stamp duty on transfer of shares held by the trust.

SEBI chief C.B.Bhave is known to be a man of action. I suggest he should check out procedures with UK Listing Authority for allowing treasury stock treatments. I hate the expression “cancel”, especially if it is used in relation to capital - not so easily found nowadays :-)


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