Dangote Cement made headlines recently with news of its share buyback, but how well do you understand the concept?
Dangote Cement Plc (DCP), Nigeria’s most capitalized stock, announced it will buy back up to 10% of her issued 10.04billion ordinary shares on December 30.
Dangote says these shares bought back will be held as Treasury Shares and subsequently canceled.
Ok, what’s Dangote up to?
It is called a Share Buy-Back (SBB). The process of an SBB involves the company buying back her issued shares from shareholders at market prices, in effect the company is investing in itself.
The company accomplishes this by utilizing her assets to exchange for shares from investors. Assets could be cash in the company’s bank account or even fixed assets that can be sold to fund the purchase.
Is this legal?
Yes, Section 161 of the Corporate and Allied Matters Act lays out the process for a company to execute an SBB, also Rule 398 (3)(xiv) of the Securities and Exchange Commission’s Rules and Regulations with Rule 13.18 of the Rulebook of The Nigerian Stock Exchange gives Regulatory backing to this action
Why a Share Buyback
A share buyback improves the financial statements of the company by boosting Shareholder Equity and Return on Assets. The SBB does this by decreasing the number of shares on the stock markets, which then boost reported earnings per share.
When a company buys shares, those shares cannot be traded on anymore, essentially those shares are extinguished which then increases the price per existing share.
Look at it this way, a company that has five company cars bought with a loan must buy gas every month, budget is N50,000 or N10,000 per car. What happens if the company decided to use the cash in their bank account, pay off the one car loan 100%
Two things will happen
- There will only be four cars, which means the N50,000 will be divided by 4 not 5, meaning each car gets 12,500 not 10,000.
- The company’s cash position will reduce because it took cash from her bank account to pay off the loan
If you think of those cars as shareholders and the budget for fuel as dividends, you can see that when the company takes its assets and reduces the number of shareholders, then the shareholders left will get a large share of dividends.
Also, instead of the company buying new tires for 5 cars, it will only buy tires for 4 cars, this cost reduction improves Earnings per Share and the Price Earnings Ratio.
That is why SBB tends to make the market share price go up because investors can project a bump in share prices, again note, even if revenues stay the same.
However, shares shall only be purchased out of profits of the company, which would otherwise be available for a dividend.
So, share buybacks are a form of dividend payment to existing shareholders because going forward they get a larger share, even if profits stay the same.
There are three reasons a company buys back its shares
The company believes her share price is too cheap. To measure cheap, I will relate DCP market price to earnings or the PE Ratio, DCP is trading at PE of 16, its competition WAPCO is trading at 17, the overall Nigeran Stock market is trading at 14.66.
A company can also wish to improve its financial ratios. Dangote EPS (TTM) is about 14.94 and easily beats WAPCO her nearest competitor that posts an EPS of 1.28 (TTM). Again Dangote does well.
Another key reason for a company to do a share buyback is if it has sufficient reserves or cash and can see no other viable options. In this instance, Dangote does carry far more debt on her books than WAPCO.
DCP Debt to Equity Is 0.56 compared to 0.15 for WAPCO, Dangote Debt is about N271.33b. The argument can be made as to why DCP cannot utilize the cash for the buyback to pay off debt.
However, in closing, keep in mind the tax treatment of Share Buy Backs to the Company, there is no effect; but to the holders of Dangote stock, they are taxed differently (lower) on dividends received because these dividends have already been taxed as part of company profits.