Share repurchase is a mechanism implemented by companies to repurchase their own shares in the market and amortize them. This in order to raise the price of them, increasing the participation percentages and the control of the shareholders.
Below we will learn more details about how and why this share repurchase process is done, as well as its advantages and implications, and potential disadvantages.
What is share repurchase and what is it done for?
To obtain financing, listed companies place their shares on a stock market, subject to compliance with the requirements that said exchange requires. This brings with it some advantages, apart from obtaining funds, such as finding new partners. They can also increase capital after the listing.
However, companies remunerate shareholders in several ways. The most common is the distribution of the dividend obtained, which is paid in cash, according to the percentage owned by each shareholder. Another alternative for this is the repurchase of own shares, also known as share buyback.
It could be said that, in a way, the repurchase of shares is contrary or opposite to the stock exchange listing. It is defined as a process in which the company acquires its own shares that are outstanding.
At first glance, and for those who do not know about these mechanisms, it might seem a little strange. However, it has its reasons. One of them, if not the main one, is that the repurchase makes it possible to amortize or eliminate outstanding shares, and as there are fewer shares, the capital stock is reduced, thus increasing the percentage of participation of each shareholder and the eventual distribution of dividends in the future.
To explain it in a simple way, let’s assume that a company has a market value of one million USD (1,000,000 USD) in one hundred thousand (100,000) shares, and one person owns ten thousand of them (10,000), which is equivalent to ten percent (10%). If the company repurchases 10% outstanding and amortizes them, the aforementioned person would now have 11.11%.
To this end, companies develop buyback programs. Its duration varies according to the number of shares to be amortized. This process can be extended for a year or more, depending on the need and other factors, including the regulations in force in the matter.
Also, there is a repurchase fund for own shares, which is part of the capital, but constitutes a separate reserve, ready for reacquisition. This is created prior to the process and is included in the legal regulations. Sometimes the shareholders’ meetings announce and make an increase in said repurchase fund, disposing of the net profits.
Benefits of share repurchase
The repurchase of shares provides a variety of benefits for the company and its shareholders. Among them, we have the following.
The value of each share
According to what has already been pointed out, the main reason for the repurchase is that, by amortizing, there will be fewer shares, so each one will represent a higher percentage and will, consequently, have a higher value, as explained in the example given.
Earnings per share
In conjunction with the foregoing, the share repurchase also implies an increase in EPS (earnings per share), which is the net return divided by the number of shares, since each share now represents a higher percentage with respect to the share capital. Of course, for this to mean a benefit in real terms, the future prospects must remain positive.
Those who own the majority of the share package are usually the first to benefit, since by reducing the total number of shares in the company, they increase their shareholding in percentage terms, without having to invest more money to buy new shares. And in this way, they have greater decision-making power regarding future operations.
Another advantage is that, unlike the dividend payment, the share repurchase has no impact in tax terms, since no income is received in the form of money. Unless the person then decides to sell the shares.
But the advantages are not only for the shareholder but also for the company, since on the one hand the cash outflow in the repurchase of shares occurs gradually; and on the other hand, the distribution of dividends, which also implies a significant cash outflow, is avoided in a single day.
Risks and disadvantages
In normal market conditions, the repurchase of shares directly benefits shareholders, since it raises the price of securities, as we have seen. And although everything seems to be working perfectly, this process has its critics and its detractors.
For example, some experts point out that the quote will not respond to the upside if the business outlook is not good. That is, the benefit of both rising stock prices and higher dividends may simply not occur if this is not accompanied by growth.
Another possible risk would be that the company could end up paying a higher value for repurchasing the shares. This would be detrimental in the sense that the price may rise above its level and then fall at the end of the repurchase process.
It is also said that a repurchase policy helps to prop up or defend the share price in the market, sending a positive message at times when there could be a potential weakness of the same. However, such a message could be interpreted ambiguously: although it is evident that the company has funds to buy, the product of its dividends, its potential for long-term growth could also be doubted.Therefore, this is a type of decision that companies cannot make without deep analysis, considering both market conditions and the health of the company, as well as the impact it will have on its finances.