Thought Experiment :This is a case study on DB Corp Buyback for this let us assume that we are in 2018 and today is 29th May, 2018. We have recently heard that DB Corp (A newspaper company: Dainik Bhaskar) is doing a buyback.
On 26/5/2018 the Board of Directors, gave approval to buyback 92 lakh shares @ 340/- being 5 percent of total paid up capital. Current market price is 260.
Promoter have expressed their intention to participate only to maximum of limit of 34 lac shares (1.85% of share capital) out of their 12.84 cr shares (69.82% of the share capital of the company).
Now from our live case study on NTPC Buyback, we know that buyback sometimes leaves out arbitrage opportunities for minority shareholders. Let us first revise what does the law states in this matter.
There is a special provision in law (Sebi Buyback Regulations,2018) for the small shareholder ( i.e who holds less than 2 lac worth shares according to the close price as on the record dates). The provision states that the company needs to take approval:
A)Either 15% of the total shares proposed to be buyback
B) or the number of securities entitled by them (small shareholders) as per their shareholding.
whichever is higher.
This results in buyback situations profit or loss decided by the small shareholder viewpoint. Such laws results in special situations created with favourable odds.
Back to Case Assessment
Shareholding of The company:
A) Small Shareholders – 46 lakhs
B) General Shareholding – 5.09 crore. However since 34 lakh shares of promoters are also their they should be added to general. So total general shareholding is 5.09 crore + 0.34 crore = 5.43 crore.
Total shares available for buyback (Small + General) = 5.43 + 0.46 crore = 5.89 crore
As per law, small shareholders will get:
A) Either, their normal entitlement which is (Small shareholders/Total Shareholders * Shares to be bought back) ((0.46/18.08) * 0.92) = 2.38 lakh shares.
B) Or, 15% of 92 lakh shares to be bought back. It comes out to be 13.8 lakh shares.
whichever is higher, so 13.8 lakh shares are reserved for the small shareholders in the buyback and 78.2 lakh shares (90-13.8) are reserved for large ones.
We will analyse the case on the basis of acceptance ratio. What is acceptance ratio?
Acceptance ratio for minority = Shares reserved for minority/total shareholding of minority that wants to participate in buyback.
In our case Acceptance ratio for majority shareholders = 0.782/5.43 = 14.4%
In our case Acceptance ratio for minority shareholders = 13.8/46 = 30%
Since the numerator in the above calculations is fixed, calculated as per law, however the denominator part is unknown and we have done the above calculations assuming all minority and majority shareholders will participate in the buyback. However, based on our limited live experience and knowledge this is rarely the case.
In order to assess the case we need to make judgement/assumptions regarding two parameters:
- The denominator for minority shareholders
- Post buyback price
Post Buyback Price: You may have different views regarding the same, we would love to hear them. We need to make a probable guess of the same using some tools.
- Pre buyback announcement price was around 250
- Current EPS of the company is 17.5 and the PE of the company is around 14 which is the lowest in previous two years. Assuming all things remaining same, the EPS of the company will increase to 18.5 after buyback. If we assume the PE to remain same the price comes around 260-265.
- PB , book value at the time of buyback is around 1929 cr and market cap near 5000 cr from which price to book roughly comes out to be 2.5. After buyback the 313 cr will be used for buyback and 1600cr will be left in the books. If we assume the PB to remain same 2.5 book value market cap comes out at 3840 cr. Which the price comes in the range of 220-230.
- Price has fallen by more than 30% in previous 5 months.
Being conservative we will assume the post buyback price to be in the range of 210-230 after buyback. Let us go back to make further cases for the buyback (Adjusting the acceptance ratio by changing the number of minority shareholders who will participate in the buyback).
Assessing Cases: Now we will assess cases with different acceptance ratio and try to pick the more probable case. In each case, we will assume that we will buy 100 shares.
Case 1: If acceptance ratio is 30% as thought (Though this is rare as some shareholders never tender their shares)
Current Market Price: 260
Price post buyback from above 215.
Total Cash Outflow = 260 * 100 = Rs 26,000 (ignoring brokerage and other expenses)
Since 30% is the acceptance ratio, then Expected Acceptance = no of our shares bought back * Buyback price announced by company( Rs340)
No of shares bought back = Shares we own * Acceptance ratio = 100 * 0.3 = 30 shares.
Expected Acceptance = 30 * 340 = 10,200
Cash Inflow = Expected Acceptance + (Shares left * Post buyback price)
= 10,200 + (70 * 215)
Acceptance Ratio of 30% seems to be priced in by the market or is the breakeven point(Cash outflow – Cash Inflow) assuming post buyback price of Rs 210-215. But we know we have taken an extreme case rarely do all the shareholders tender their shares.
Case 2: Acceptance ratio is thought to be 50%
We will buy again 100 shares.
Cash Outflow: 100*260 = 26,000
Expected Acceptance: 50*340 = 17000
Cash Inflow: 17000 + (50*215)
Here we make a pre tax return of 6.5%. Since most of the buyback on an average our completed on 2-3 months, it gives a good margins of safety.
1. We think 50% acceptance ratio is a probable case based on our limited experience and past case studies of buyback (Bayes Estimate), however you may differ on this. We would love to hear your views. We would like to know how you would have improved the odds using what thinking model. Better sense will be to consider whether this situation is like our past ones or different as we are using bayes odds.
2. Two main variables determine in this thinking model the success or failure of this kind of buyback special situation:
a) Post buyback price
b) Acceptance ratio
Another variable, is the time such situation will take to complete. We have assumed it should be 2-3 months, however longer the time less returns more the uncertainty.
3. We have used this model, however we will love to learn from you where and when this thinking model of acceptance ratio does not work.
Let us assume we took a position as a minority shareholder in the above situation. Before going ahead we would like you to think that what would you have done.
(PLEASE CLICK ON PAGE 2 MENTIONED TOWARDS THE LOWER END OF THE POST TO SEE WHAT HAPPENED)