January 06, 2009 6590 VIEWS

As part of measures taken by the regulators to boost confidence and encourage the return of liquidity to the stock market, the prospect of allowing companies to buyback their own shares was introduced. Other measures suggested like the introduction of market makers and the lifting of the so called 1% circuit breaker had already been implemented.


Guidelines were issued for prospective market makers and three applications have been approved so far. However, the share buyback option has been slow in its implementation. The Securities and Exchange Commission (SEC) has already rolled out the preliminary guidelines for companies interested in exercising this option. The practice of share repurchase may be novel in the Nigerian capital market; but has been widely practiced in more advance economy.


In some countries, including the United States and the United Kingdom, corporations can buy back their own stock in a share repurchase, also known as a stock repurchase or share buyback. There has been a meteoric rise in the use of share repurchases in the U.S. in the past twenty years, from $5b in 1980 to approximately $349b in 2005. A share repurchase distributes cash to existing shareholders in exchange for a fraction of the firm\'s outstanding equity. That is, cash is exchanged for a reduction in the number of shares outstanding. The firm either retires the shares or keeps them as treasury stock, available for re-issuance.



Companies making profits typically have two uses for those profits. Firstly, some part of profits is usually repaid to shareholders in the form of dividends. The remainder, termed retained earnings, are kept inside the company and used for investing in the future of the company. If companies can reinvest most of their retained earnings profitably, then they may do so. However, sometimes companies may find that some or all of their retained earnings cannot be reinvested to produce acceptable returns.


Share repurchases are one possible use of leftover retained profits. When a company repurchases its own shares, it reduces the number of shares held by the public so, even if profits were to remain the same, this would have the effect of increasing earnings per share. So, repurchasing shares, particularly when a company\'s share price is undervalued or depressed, can provide a competitive return on investment.


One reason why companies may prefer to keep a substantial portion of earnings rather than distribute them to shareholders, even if they are not able to reinvest them all profitably, is that it is considered very embarrassing for companies to be forced to cut dividends.


So, rather than pay out larger dividends during periods of excess profitability then have to reduce them during leaner times, companies prefer to pay out a conservative portion of their earnings, perhaps half, with the aim of maintaining an acceptable level of dividend cover.


Another reason why executives, in particular, may prefer share buybacks is that Executive compensation is often tied to executives\' ability to meet earnings per share targets. In companies where there are few opportunities for organic growth, share repurchases may represent one of the few ways of improving earnings per share in order to meet targets.


Share repurchases also allow companies to covertly distribute their earnings to investors without inflicting them with double taxation. This only holds true in jurisdictions which do no operate imputation tax credit systems.


In the Nigerian context, there may be other reasons. It is common practice in the Nigerian capital market to see companies giving mandate to brokers to purchase there own shares.


Since the company giving such mandate would most likely finance the purchase, in this regard, it can be viewed as an indirect way of share repurchase. The mandate given may last up till such a time that the desired level of share price is reached. The company would normally have a target price in mind before embarking on such indirect share repurchase.


This practice was rampant in the early part of 2007 when share prices were pushed northward ahead of public offers, although none of the culprits would admit to this.


However, things are different now that companies who so desire would be allowed to repurchase its shares, as long as it complies with SEC guidelines. Under the SEC rule, the total number of shares that can be repurchased shall not exceed 15% of the existing issued and paid up capital in any given financial year.


Such shares can only be repurchased out of the share premium account or cumulated profit of the company which would otherwise be available for dividend payment. Therefore, borrowing for the purpose of share repurchase would not be allowed. The shares purchased would then be cancelled in accordance with the procedures set out under the Companies and Allied Matters Act (CAMA) of 1990.




Open Market Share Repurchases

The most common share repurchase method in the United States is the open-market stock repurchase, representing almost 95% of all repurchases. A firm may or may not announce that it will repurchase some shares in the open market from time to time as market conditions dictate and maintains the option of deciding whether, when, and how much to repurchase.


Open market repurchases can span months or even years. There are, however, daily buyback limits which restrict the amount of stock that can be bought over a particular time interval.


Fixed Price Tender Offer Repurchases

This offer specifies in advance a single purchase price, the number of shares sought, and the duration of the offer, with public disclosure required. The offer may be made conditional upon receiving tenders of a minimum number of shares, and it may permit withdrawal of tendered shares prior to the offer\'s expiration date. Shareholders decide whether or not to participate, and if so, the number of shares to tender to the firm at the specified price.


Dutch auction Share Repurchases

A Dutch auction offer specifies a price range within which the shares will ultimately be purchased. Shareholders are invited to tender their stock, if they desire, at any price within the stated range. The firm then compiles these responses, creating a demand curve for the stock. The purchase price is the lowest price that allows the firm to buy the number of shares sought in the offer, and the firm pays that price to all investors who tendered at or below that price. If the number of shares tendered exceeds the number sought, then the company purchases less than all shares tendered at or below the purchase price on a pro rata basis to all who tendered at or below the purchase price.


In Nigeria, SEC rules stated that the buy-back shall be either through the Open Market or through Self-Tenders offer. The maximum time allowed for the completion of buy-back process shall not be more than 12 months from the date of the shareholders resolution.


The shareholders’ resolution shall be special resolution as provided in the CAMA. Also For the purpose of the buy-back through open market, the company shall not use more than two Stockbroking companies (who shall not be a subsidiary of the company) for each programme.



Share buyback, particularly when a company\'s share price is undervalued or depressed, can provide a competitive return on investment. Apart from following SEC rules, the Nigerian Stock Exchange can support SEC by ensuring that possible abuses are minimized. Also, companies that do not publish audited accounts and interim accounts regularly should be disqualified. Companies with issues relating to corporate governance should also be disqualified for repurchasing their shares. A lot rests on the regulators to ensure that the system is protected.





While the Proshare website is renowned for its  accuracy and painstaking attention and commitment to factual data, we are not liable for any incorrect information included. We recommend that you make enquiries based on your own circumstances and, if necessary, take professional advice before entering into transactions.This report is based upon information from various sources that we believe are reliable. However, we do not make any representation as to the accuracy or completeness of the report. This report is not an offer to buy or sell, nor a solicitation to buy or sell the securities mentioned therein. This report is provided solely for the information of clients of LeadCapital Limited (LeadCapital) who are expected to make their own investment decisions without sole reliance on this report. LeadCapital and PROSHARE (publishers of the report under approval) accepts no liability for any direct or consequential loss arising from any use of this report or its contents. Investments can fluctuate in price and value and the investor may get back less than was originally invested. Past performance is not necessarily a guide to future performance. This information has been issued by LeadCapital, which is licensed by the Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange (NSE). Enquiries relating to any matters in this report should be directed to 01 4611269 ext 130.





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