As a service for those who may not have prior experience with stock repurchase strategies, we provide background information on some general questions.
Why do companies do share buybacks?
A share buyback is a method of capital return to shareholders. Companies may choose to repurchase shares for several reasons. Some may use share buybacks as a method to utilize excess cash flow rather than keeping the cash on the balance sheet, while some may decide to buy back shares if they view the shares as undervalued. Some companies also enter into share repurchases to offset dilution from employee stock options, mergers and acquisitions (M&A), or other dilutive contracts. Share buybacks can also have the benefit of increasing the earnings per share (EPS).
When should a company do a buyback?
Once a share repurchase authorization is approved, a company will typically have flexibility to determine when the actual buying occurs. A company needs to be mindful of its open and closed trading windows. The general practice is to purchase shares pursuant to an SEC safe harbor called Rule 10b-18. If a company is in an open window (see below), it can give orders to a broker on any day that it does not have any material nonpublic information. A company may also consider buying back shares during a closed period. To effect these purchases, a company needs to enter into a plan that complies with the requirements of Rule 10b5-1. A company can only enter into a Rule 10b5-1 plan at a time when it has no material nonpublic information. Different companies will have varying requirements for cooling off periods as well, defining how soon after establishing the Rule 10b5-1 plan the broker can start the actual buying of shares thereunder.
What is an open window?
Most public companies adopt a policy forbidding trading in company’s securities by employees, officers, and directors in periods when it is likely to possess material nonpublic information. The periods when trading is not permitted are referred to as “closed windows.” Closed windows typically start a few weeks before the end of the fiscal quarter and end shortly after the earnings announcement. Periods when trading is permitted under these policies are referred to as “open windows.” Even in an open window, no trading decisions should be made when a person actually possesses material nonpublic information.
What rules apply to a share buyback?
There are many rules and laws that are relevant to share buybacks. For share repurchases that are not tender offers, the two most commonly referred rules for public companies in the United States are Rule 10b-18 and Rule 10b5-1 under the Securities Exchange Act of 1934 as amended (Exchange Act). As mentioned above, these rules are “safe harbors” that provide guidelines to reduce potential liability under US securities laws when their requirements are met.
Rule 10b-18 is non-exclusive, providing a safe harbor to issuers and certain of its affiliated purchasers from liability under certain market manipulation rules and Rule 10b-5 under the Exchange Act (when repurchases of the issuer’s common stock satisfy the Rule’s conditions as to when, where, and how share repurchases can occur).
Rule 10b5-1 provides that any person executing pre‐planned transactions pursuant to a Rule 10b5‐1 plan that was established in good faith (at a time when that person was unaware of material nonpublic information) has an affirmative defense against accusations of insider trading.
The US Securities and Exchange Commission has proposed amendments to these rules, so potential changes to how share repurchases are executed are likely when those proposals are finalized. Please get in touch with the Matthews South team to discuss the potential impact of these changes in more detail.
How does a share buyback work?
There are a number of alternatives a company can consider when repurchasing shares. Open Market Repurchase (“OMR”) is the most common method, though more structured alternatives such as the Enhanced Open Market Repurchase (“eOMR”) or Accelerated Share Repurchase (“ASR”) are also frequently used. Depending on the situation, companies may also consider an issuer Tender Offer, Privately-Negotiated Buyback, or Pre-Paid Put Options to complete their buyback or supplement an existing strategy.
Do shareholders have to sell shares in a buyback? How do shareholders benefit from stock buyback?
Shareholders do not have to sell their shares once a company announces a share buyback and can decide to keep holding their shares. After a buyback, there will be fewer outstanding shares, so each shareholder will own a greater percentage of the company. A buyback also temporarily increases the demand for the company’s stock while the company is executing its share repurchases.
Is share buyback a good signal?
Share buybacks generally send a signal to the market that a company is committed to returning capital to shareholders. Depending on the method of buyback execution and frequency of conducting buybacks (i.e. on a quarterly basis or more sporadic), this signal can be stronger or weaker. Generally, an Accelerated Share Repurchase (“ASR”) is seen as a strong commitment, given the company is paying for the buyback upfront. It is also common for companies to announce ASR transactions via a press release to increase transparency to the market (even when disclosure might not be required under relevant securities laws). It is difficult to achieve the same level of messaging with open market repurchase, as open market buyback activity is typically disclosed quarterly with earnings when a lot of other important information comes to market as well.
Do buybacks increase share price?
Deciphering share price reaction to buybacks is a difficult task as the reaction is often a cumulation of multiple factors, including size of buyback, method of execution, and any news that may be announced concurrently. More often than not, the market tends to have a positive reaction to announcements of share buyback programs.
What happens to the share price after buyback?
While announcement of a buyback may result in a positive share price move and buying back shares consistently in the market may provide support for the share price, the long term stock price performance is ultimately driven by the company’s overall performance, market liquidity, and investor sentiment.
Do stock buybacks reduce market cap?
A share repurchase will reduce the market capitalization (or market cap) of a company. This is because stock buybacks reduce the company’s shares outstanding and the market cap is the product of the shares outstanding and stock price. The decrease in market cap from a share repurchase should be equivalent to that from a dividend paid of an equivalent amount.
Can a company buy back all of its shares? What happens if a company buys back all shares?
If a company affects a purchase that is intended to or may result in the company’s stock being held by (1) fewer than 300 persons or (2) no longer listed on an exchange, it will be considered a “going private” transaction and subject to Rule 13e-3 of the Exchange Act.
Why do companies use Accelerated Share Repurchase (“ASR”), also known as Accelerated Share Buyback (“ASB”)?
Companies use ASRs for a number of economic and non-economic reasons, some of which include:
- Signaling – ASRs provide a natural platform to communicate a positive business outlook or commitment to capital return,
- EPS Accretion – with majority of shares retired upfront (vs. over time in a typical Open Market Repurchase Program), the impact on EPS accretion can be meaningful,
- Committed Performance – ASRs provide a fixed or formulaic discount to the average price over the program execution period that the bank counterparty agrees to when entering into the ASR.
Why should companies not use Accelerated Share Repurchase (“ASR”)?
While ASRs have many benefits, there are some important considerations to be mindful of:
- Commitment – ASRs are prepaid upfront and there is not an easy way to unwind an ASR after the initial delivery of shares occurs,
- Early Completion Risk – if not structured carefully, an ASR may complete when it is advantageous for the company to continue buying shares,
- Complexity – ASRs are derivative contracts and require complex documentation, disclosure and accounting analysis to deal with the many unanticipated events that can occur before ASR is completed.
What is an Enhanced Open Market Repurchase (“eOMR”)?
The eOMR is an increasingly popular execution alternative because it provides volume-weighted average price (VWAP) economics that are similar to an ASR but with the flexibility of an open market program. It allows companies to repurchase shares in an efficient manner and benefit from stock price volatility. This strategy tends to be more expensive if sourced from banks. We created the Matthews South eOMR that completely eliminates substantially all of this excess cost. Please reach out to our team if you would like to discuss this strategy in more detail.
What is a tender offer?
Some companies may elect to repurchase shares via a tender offer. Issuer tender offers may be structured as a “fixed price”, where shareholders are invited to tender their shares at a fixed price, or as a “Dutch Auction”, in which an issuer invites shareholders to tender their shares at a predetermined range of prices and shares are purchased at a clearing price. A tender offer is generally made for a fixed number of shares (or a fixed dollar amount) and has to be open for at least 20 business days. The period must be extended if there are any material changes within 10-days of the expiration of the tender offer period.
Who is eligible for the buyback of shares in a tender offer?
Shareholders who own the shares on the record date for the tender offer can tender their shares during the tender period, which is set by the company in its offer. Shareholders who fail to sell their shares before the end of the specified period will not be able to use this buyback option and can sell their shares in the open market.
Are share buybacks better than dividends?
Share buybacks and dividends are both ways of returning capital to shareholders. Dividends can be structured as ongoing (typically quarterly) cash distributions, or as special dividends, where excess capital is given to shareholders in the form of a one-time payment. Dividends offer fixed payments to all shareholders, while share buybacks provide liquidity only to selling shareholders. From a company’s perspective, share buybacks tend to be a more flexible form of returning capital to shareholders compared to dividends. The chosen method of capital return may also have an impact on the shareholder base, with dividends generally attracting yield investors. Additionally, a dividend is a taxable event for shareholders whereas a share repurchase is currently not a taxable event (i.e., the shareholder recognizes the taxes only when they decide to sell shares).
Are share buybacks taxable for investors?
Share buybacks do not result in a taxable event as investors only pay taxes once the shares are sold. On the other hand, dividends are taxed when paid. The difference in tax implications may cause investors to favor one capital return strategy over another. Additionally, recent bills before Congress may result in a buyback tax in the United States. Please get in touch with the Matthews South team to discuss the potential impact of changes in more detail.
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