Invest talk: Buyback skips tax liability

There is talk of ‘asking’ Infosys to go in for a share buyback. The logic is that there is cash sitting on the balance sheet and the company has no need to keep so much cash, apart from being immensely profitable.
The current cash EPS is around Rs 200 and the current market price is around Rs 3,600.

In other words, if the company were to buy back shares, it would pay, say, Rs 3,600 per share. Since it has cash in the bank, none of its operations would be adversely impacted.
If we assume that the idle cash is earning around seven per cent per annum, it would mean a decline in its income or profit before tax by around Rs 252 for each share it buys back.

In other words, cash earnings would decline. I can make the example a bit more complex by assuming that the company buys back one per cent, two per cent, five per cent and so on.

The key thing to me is what do we expect from the company over the next few years. If we assume that earnings grow by 10 per cent each year, the company’s cash EPS will move to around Rs 250 in a little over two years. Thus, if there is faith in the business, buy back is a good thing. Faith refers to the confidence to grow earnings from here at a respectable 10 per cent plus year on year.

When the cash EPS crosses Rs 252, the buyback becomes viable so long as interest rates remain where they are. If the interest rates were lower, then the price becomes even more attractive. Conversely, if the company could earn, say 10 per cent per annum on its cash balance, the buyback at Rs 3,600 may not be as appealing.

What does this mean if one is a shareholder of Infosys? To me, the answer is simple. Irrespective of the buyback, does the share merit a buy or a sell at this price? The buyback does not make any difference. However, if you are sitting on the fence, then a buyback decision by the company makes it better to hold on to the shares. Surely, if the company does buy back the shares it wants to, the residual shareholders should be better off, assuming reasonable growth.

One could ask the company to distribute the cash as dividend. In this case, the dividend distribution tax will take away nearly a third of the cash. In a buyback, the company does not suffer this taxation burden.

As a shareholder, if there is a buyback programme where one is supposed to tender the shares to the company, take care.  Due to a regulatory quirk, any shares submitted under a buyback programme do not go through the floor of the exchange and do not suffer STT.

In such a case, the capital gains tax is applicable, which takes away a part of your realisation. It is best to sell the shares in the secondary market, under the present tax regime.
(The writer is an independent analyst and can be contacted at balakrishnanr @gmail.com)