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With TCS buyback opening on March 9, it is time to focus on realities and away from headline grabbing ‘how much returns you can make’ based on fantasy acceptance ratios.
The original purpose for which buybacks were conceived was to give managements/corporate boards a tool to signal to shareholders that in their view the company’s shares are undervalued. In India many a times it is used for anything but this.
(read our Big Story in portfolio edition dated September 5, 2021: ‘Why all stock buybacks are not buy signals’).
Further, SEBI rules mandating 15 per cent of offer size be reserved for small shareholders (holding shares up to a value of ₹2 lakh), brings in arbitrage opportunity into stock buybacks for small shareholders to buy at lower price and flip it at higher buyback price for some quick bucks.
What it means to fundamentals
From a pure fundamental analysis perspective, buybacks add no value to a stock as compared to dividends other than when large buybacks are done when a stock is undervalued.
Based on the above factors, the TCS buyback is completely insignificant from a fundamental perspective. The buyback represents a miniscule 1.1 per cent of its outstanding equity. Further the TCS stock is anything but undervalued, as buyback as a tool is meant to indicate.
At its current price, TCS is valued at a rich 31 times FY23 PE (Bloomberg consensus), the stock is trading at a good 25 per cent premium to its 5 year average valuation, in an environment reeling with geopolitical and economic uncertainties. Further at the buyback price of ₹4,500, TCS is valued at FY23 PE of 37.5 times. Global IT consulting and IT services leader Accenture trades cheaper versus TCS at 27 times.
What should an investor do?
As compared to past buybacks of TCS done in the years 2018 and 2020, when during the buyback window period TCS shares had rallied right close to the respective buyback prices then, this time the stock is languishing at a good discount to the buyback price. The buyback price is currently (closing price on March 8) at a 25 per cent premium.
This indicates investors’ view that the buyback price is way above fundamental value of the stock. This also logically implies most investors will tender their shares, resulting in lower acceptance ratios. TCS promoters who own 72 per cent of the company have also said they will be tendering their shares for the buyback as they have done in 2018 and 2020, thus consuming most of the buyback value of ₹18,000 crore.
As of December 31, shareholders with less than ₹2 lakh in value owned 3.6 per cent of TCS shares. With 15 per cent of the buyback reserved for them (15 per cent*1.1 or 0.16 per cent of outstanding shares will be bought from them), assuming all of them tender, the acceptance ratio will be around 5 per cent (0.16/3.6). The acceptance ratio could be even lower if the percentage of small shareholders has increased in anticipation of the buyback
Thus for example, if you had ₹1.5 lakh worth of TCS shares today and tendered in the buyback, based on the above assumption, roughly ₹7,500 worth of your shares will be accepted. And this when compared with its current share price, will yield you a meagre profit of ₹1,875 (25 per cent buyback premium over current share price) on your current investment value of ₹1.5 lakh.
This works out to an extra return of a paltry 1.25 per cent on your investment (1,875/1,50,000). This is why the buzz around this TCS buyback is mostly hype and less of substance. If you are above the ₹2 lakh value shareholder and thus not a small shareholder, your returns will be even significantly lower than what is mentioned above.
So should you tender? Well, that depends on whether the extra 1.25 per cent returns mentioned above matters to you.
Finally, here is the catch – if many investors feel the extra returns are not much and do not bother to tender, then the acceptance ratio can be higher, and returns will be higher. If the acceptance ratio is 10 per cent, then the returns will be proportionately higher at 2.5 per cent. But the probability of that is likely low. And even otherwise, the returns are not going to be great.
Bottomline, if you thought the TCS buyback was big thing, no its not. It isn’t much different from the same money distributed at a dividend yield of 1.1 per cent.
At BL Portfolio we had given a book profit recommendation in TCS in January 2021 when the stock was at ₹3,303. The stock has returned 9 per cent since then, underperforming the Nifty 50’s 16 per cent returns. We maintain our book profit recommendation in the stock as despite the sustained good performance by the company since initial Covid impact in June Q of 2020, its valuations appear to have run ahead of fundamentals. As mentioned above, the stock is expensive when compared with its historical valuation or with close peer Accenture. Till recently TCS always used to trade at a discount to Accenture for many years. It is hard to justify its current valuation when its 5 year earnings CAGR has just been at 10 per cent. Further a greater percentage of the TCS share price returns in recent years has come from valuation multiple expansion. In the current environment of geopolitical uncertainties combined with US Fed embarking on monetary tightening, multiple compression is likely, as higher interest rates will make equities less attractive on a relative basis. Investors also need to monitor whether these global factors impact client budgets and thereby revenues for companies like TCS.
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