Sometimes the only good thing to come out of buybacks by Indian IT services companies is that it makes you do some math. If the same money was given to shareholders as dividends, then investors are spared the number crunching. For example, say the current ₹12,000-crore Wipro buyback, which opens today (June 22) for tendering and closes on June 29, was instead distributed as dividend? For each share owned, investors would have got a dividend of around ₹22, translating into a dividend yield of 5.7 per cent at yesterday’s close price of ₹386. The shares will decline somewhat to adjust for the payout on ex-dividend date, but investors pocket a decent dividend. Simple.
But, alas! that is not to be. Since there’s a buyback, investors need to brush up on math skills and compute fancy return ratios based on scenario analysis of how much money they can make depending on the buyback acceptance ratio. Based on such analysis, our recommendation is that investors are better off tendering the shares. With the buyback priced at nearly 22 times trailing PE, and at a good 34 per cent premium to pre-Covid five-year average valuation of Wipro, investors can tender and pocket the cash.
First, the numbers behind the buyback
While the company intends to buy back shares accounting for 4.91 per cent of outstanding shares, the percentage bought back from you will vary, depending on which category of investor you are, as well as how many tender their shares. SEBI rules mandate that 15 per cent of the buyback amount must be reserved for small shareholders, namely those with equity shares valued not above ₹ 2 lakh. Based on this, as indicated in company filings, small shareholders can expect buyback of a minimum of 23 per cent of the shares they tender. The current premium of the buyback price at ₹445 over yesterday’s close price of ₹386 is 15 per cent. This would mean returns (short-term profits) of around 4 per cent (23/100*15) on their current holdings. This is lower than the hypothetical dividend yield! But it does not end there. With share count reduced via buyback, the EPS will increase (even if earnings are flat). To that extent, theoretically, over a period of time the share prices must appreciate to factor this. If earnings growth in future turns out to be robust, then the share price appreciation can be even better.
On the other hand, if the acceptance ratio is 100 per cent, then it is a simple 15 per cent return for the investor, but no stake in the future performance of the company.
Thus the scenarios are wide.
Why you must tender
Buybacks add value to non-tendering investors only when done at undervalued levels, which is not the case this time. Hence not tendering now will mean getting left out. The only reason to pass a buyback would be when the stock is undervalued and there is a case that, over a period of time, markets will recognise this. In such cases, investors who do not tender will benefit from share price appreciation. However, it is clear that Wipro shares are not undervalued, although one can argue that it is not very expensive. Trading at a trailing PE of 19 times, Wipro shares are trading at premium of 18 per cent to pre-Covid five-year average valuation, while the buyback price is at a 34 per cent premium. Amidst an economic slowdown playing out in the US and Europe — key markets (account for close to 90 per cent of revenue) for the company, the earnings growth prospects for the company are also at risk.
Further, even if one were to look past these medium-term risks, the shares are not cheap. The five-year (FY18-23) earnings CAGR of Wipro is 11 per cent. The rolling five-year earnings CAGR since 2017 (tracks its earnings performance over the last decade) has beenmid-single digits to low-double digits percentage. Based on these facts, too, a PE of 19 times is not cheap.
Thus, with shares not undervalued, this buyback is unlikely to create any meaningful value for long-term shareholders. Analysis of buybacks of IT services companies since 2020 indicates that, across the board, buybacks have not created value for investors. Hence tendering shares is the way to go.
At bl.portfolio, we had recommended a book profit on the shares of Wipro when it was quoting at ₹513 in May 2021, and the shares were trading at a very expensive PE of 27 times. While the shares and valuation multiples have since compressed significantly, uncertainty in business outlook implies a wait-and-watch approach is still warranted.