Vimal & Sons

April 18, 2021

Infy Buyback - What's Different This Time

(Disclosure: I am long Infy, so readers may consider my views as biased) 

Before I explain what is different about the latest Infy buyback, I think it is necessary to understand what is meant by a stock buyback. Unfortunately, the concept has been butchered in India and the regulator is directly responsible for the misuse of the concept by corporate India.

As per SEBI guidelines, corporate India can engage in two types of buybacks. These are: (1) Tender Offer Buybacks where existing shareholders (including the promoters) can submit some of their holdings and the company buys them at a price that is above the market price and (2) Open Market Buybacks where the companies proceed to buy shares from the open market.

To the best of my knowledge, this concept of a tender offer buyback doesn’t exist anywhere else in the world. Tender offer buybacks should never have been allowed to start with. It is an Indian invention and in a way, it is Indian Juggad at its very best. But, this post isn’t a rant, so I’ll stop there.

The second type of buyback, buying shares from the open market is something that Infy hasn’t done till date. They have executed many tender offer buybacks in the past. But, this time they have taken the open market route, and hence this time the buyback is materially different from all past buybacks.

Buying back shares from the open market, is one of the least understood concepts amongst investors. So, let me start by educating readers of what a stock buyback is. What is meant by the term, ‘buyback of shares’ and when is it considered prudent to announce a buyback?

Any business that is generating cash has broadly five ways in which it can use the surplus cash that it generates. These are:

  1. Distribute it to shareholders via dividends.
  2. Pay down debt.
  3. Acquire other businesses be they related or unrelated - diversify.
  4. Invest in expansion of existing business.
  5. Buyback stock from the open market.

We are concerned primarily with the fifth option. When should a company buy its shares back from the open market? In the words of Buffett:

“I think the best use of cash, if you don’t have a good use for it in the business, if the stock is underpriced, is to repurchase it. And if it’s overpriced, you got no business buying in a single share. But a lot of companies do it.”

In other words, we are talking about what a business does with the excess cash that it generates, over and above that required for running the day to day operations. And, the idea is not to waste money, since there are so many ways in which excess cash can be spent. It is a matter of capital allocation. Unfortunately, capital allocation as an important corporate function is highly underrated by almost everyone.

Good Capital Allocation takes many forms and it does not necessarily require a business to grow. When one is investing for the long-term, two things are more important than just the growth potential of the business and these are:

  • the quality of the business and
  • the quality of the managements capital allocation decisions.

The longer that investors hold their shares, the more their investment outcomes are linked to these two metrics than to anything else.

Considering all of the above as background information, the fact that Infy has chosen to buy back shares from the open market is a capital allocation decision that seems to make sense in a low return world. I mean the Infy management could have:

  • announced a special dividend
  • done a tender offer buyback, like they have done so many times in the past and like TCS did recently
  • they are a zero debt company, so the question of paying down debt doesn’t arise
  • been acquisitive, but looking at the startup valuations, I suppose they chose not to (my assumption)
  • done something dumb, like diversify into completely unrelated businesses (incidentally, ITC has been burning shareholder money in this way for more than a decade)
  • they could have chosen to do nothing, just treat the surplus as retained earnings

Instead, what they have done is that they have chosen to buyback roughly 1.23 percent of the floating stock. The total amount allocated to the buyback is Rs. 9200 crores. (Considering the price action post the buyback announcement, they will in all probability end up buying slightly more than the 1.23 percent, closer to 1.5 percent of the floating stock). What’s the big deal about Infy buying back 1.23 percent of the floating shares from the open market? My thoughts: 

  • In terms of capital allocation, it signals a change in thinking and I think we are going to see more of these buybacks in the future. The management is now thinking in terms of shareholder value and that should be applauded.
  • The shares that are repurchased by the company are extinguished and that reduces the share count. Over the long-term, that leads to a shrinkage in the floating stock and a proportionate increase in the ownership stake of the remaining shareholders.
  • A lower share count leads to an increase in shareholder value for the remaining shareholders. I don’t want to get too much into the weeds about these concepts; suffice to say that as long as Infy can continue to execute in the future as they have been doing in the recent past, buying Infy and holding it for the long-term makes sense.

I have not used the word valuation at any point in this post. Is Infy fairly valued, undervalued or overvalued as on date (Rs. 1353.75)? This is such a vexed question. Valuation is akin to beauty lying in the eyes of the beholder. Moreover, I don’t think there is definitive answer to the valuation question. There are a plethora of opinions, but I couldn’t care less for any of them. 

Infy may not be growing at the rate the street expects them to grow. Hence, the price action post the buyback announcement has been tepid. Instead of dancing around valuation metrics and street expectations, I prefer to trust the management. And since they have pivoted in terms of their Capital Allocation policies, I prefer to give them the benefit of the doubt about the current valuation. They should know best, shouldn’t they? After all, they have proved their naysayers wrong, time and again. To execute this trade, requires one quality that is in short supply among most of us (me included), and that is patience.

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