Shares:Buyback & Split

What is a Stock Split?
A stock split is a corporate action which splits the existing shares of a
particular face value into smaller denominations so that the number of
shares increase, however, the market capitalization or the value of shares
held by the investors post split remains the same as that before the split.
For e.g. If a company has issued 1,00,00,000 shares with a face value of Rs.
10 and the current market price being Rs. 100, a 2-for-1 stock split would
reduce the face value of the shares to 5 and increase the number of the
company’s outstanding shares to 2,00,00,000, (1,00,00,000*(10/5)).
Consequently, the share price would also halve to Rs. 50 so that the market
capitalization or the value shares held by an investor remains unchanged. It
is the same thing as exchanging a Rs. 100 note for two Rs. 50 notes; the
value remains the same .
Let us see the impact of this on the share holder: - Let's say company ABC
is trading at Rs. 40 and has 100 million shares issued, which gives it a
market capitalization of Rs. 4000 million (Rs. 40 x 100 million shares). An
investor holds 400 shares of the company valued at Rs. 16,000. The
company then decides to implement a 4-for-1 stock split (i.e. a shareholder
holding 1 share, will now hold 4 shares). For each share shareholders
currently own, they receive three additional shares. The investor will
therefore hold 1600 shares. So the investor gains 3 additional shares for
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each share held. But this does not impact the value of the shares held by
the investor since post split, the price of the stock is also split by 25%
(1/4th), from Rs. 40 to Rs.10, therefore the investor continues to hold Rs.
16,000 worth of shares. Notice that the market capitalization stays the same
- it has increased the amount of stocks outstanding to 400 million while
simultaneously reducing the stock price by 25% to Rs. 10 for a capitalization
of Rs. 4000 million. The true value of the company hasn't changed.
An easy way to determine the new stock price is to divide the previous stock
price by the split ratio. In the case of our example, divide Rs. 40 by 4 and
we get the new trading price of Rs. 10. If a stock were to split 3-for-2, we'd
do the same thing: 40/(3/2) = 40/1.5 = Rs. 26.60.
Pre-Split Post-Split
2-for-1 Split
No. of shares 100 mill. 200 mill.
Share Price Rs. 40 Rs. 20
Market Cap. Rs. 4000 mill. Rs. 4000 mill.
4-for-1
No. of shares 100 mill. 400 mill.
Share Price Rs. 40 Rs. 10
Market Cap. Rs. 4000 mill. Rs. 4000 mill.
Why do companies announce Stock Split?
If the value of the stock doesn't change, what motivates a company to split
its stock? Though there are no theoretical reasons in financial literature to
indicate the need for a stock split, generally, there are mainly two important
reasons. As the price of a security gets higher and higher, some investors
may feel the price is too high for them to buy, or small investors may feel it
is unaffordable. Splitting the stock brings the share price down to a more
"attractive" level. In our earlier example to buy 1 share of company ABC you
need Rs. 40 pre-split, but after the stock split the same number of shares
can be bought for Rs.10, making it attractive for more investors to buy the
share. This leads us to the second reason. Splitting a stock may lead to
increase in the stock's liquidity, since more investors are able to afford the
share and the total outstanding shares of the company have also increased
in the market.
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What is Buyback of Shares?
A buyback can be seen as a method for company to invest in itself by buying
shares from other investors in the market. Buybacks reduce the number of
shares outstanding in the market. Buy back is done by the company with
the purpose to improve the liquidity in its shares and enhance the
shareholders’ wealth. Under the SEBI (Buy Back of Securities) Regulation,
1998, a company is permitted to buy back its share from:
a) Existing shareholders on a proportionate basis through the offer
document.
b) Open market through stock exchanges using book building process.
c) Shareholders holding odd lot shares.
The company has to disclose the pre and post-buyback holding of the
promoters. To ensure completion of the buyback process speedily, the
regulations have stipulated time limit for each step. For example, in the
cases of purchases through stoc k exchanges, an offer for buy back should
not remain open for more than 30 days. The verification of shares received
in buy back has to be completed within 15 days of the closure of the offer.
The payments for accepted securities has to be made within 7 days of the
completion of verification and bought back shares have to be extinguished
within 7 days of the date of the payment.