A share buyback is where a company purchases its own shares either on the open market through a broker or directly from existing shareholders by way of a tender offer. The repurchased shares are then either cancelled or held in treasury.
The rationale for a share buyback is usually driven by the need to create value for existing shareholders. When a company buys up its own shares, it means there are fewer shares available to purchase on the open market; and basic supply/demand economics suggests that with a reduced number of shares in circulation, this should help underpin the share price.
Of course, it doesn’t always follow that the share price will remain at the buyback level. External events can impact on the value of a company and the share price can decrease despite managements’ efforts to prop up the price.
Another criticism of share buybacks is that some shareholders are of the view that excess cash on the balance sheet should not be used to purchase the company’s own shares; instead, the cash should be used to enhance earnings; either by acquiring another business or expanding into a new product line or geographical market.
A share buyback is also known as a transaction in own shares, a stock buyback or as a share repurchase.
Examples of share buybacks
In a previous role, I did actually get involved in a share buyback programme and was responsible for managing the process on behalf of a private property company.
Many property companies set up stand-alone SPVs (Special Purpose Vehicles), for example, to acquire and redevelop say an office block as a one-off project. Once the project is complete, the SPV is usually liquidated and surplus cash (profit) returned to shareholders.
The cash can be returned by way of a special dividend or a share buyback or a combination of both. Sometimes, it can be more tax efficient to return cash by purchasing shares as some of the profit (gain) can be sheltered from capital gains liability by using up the individual shareholders annual capital gains allowance (£6,000 for 2022/23).
While my own experience is probably atypical of the share buybacks we see on the stock market, it might be useful to explore some of the reasons that listed companies use to carry out this type of corporate action:
1. Yellow Cake Plc
Yellow Cake Plc (YCA), an AIM listed company operating in the uranium sector, decided to undertake a share buyback programme because the directors believed that the prevailing share price was trading at a material discount to YCA’s underlying net asset value.
The share buyback enabled YCA to acquire exposure to uranium at a discount to the commodity spot price. The repurchased shares were then held in treasury and presumably at some future date, the company has the option to sell these shares back to the market at a profit, for the benefit of all the company’s shareholders or indeed cancel them.
2. San Leon Energy
San Leon Energy (SLE) is an AIM listed company operating in oil and gas production, development and exploration, mainly in Nigeria. The directors decided to return excess capital of USD 30 million to shareholders by way of a tender offer.
A tender offer is a process whereby the company agrees to buy a certain amount of shares at a fixed price on or before a specified date. In this case SLE made a proposal to all qualifying shareholders to purchase up to 10% of their shares at a price of 46p per share.
At the time of the offer, this represented a 50% uplift on SLE’s prevailing share price, giving shareholders a healthy capital gain. The repurchased shares were then cancelled which in theory acts as a support to the share price.
3. Gulf Keystone Petroleum
Gulf Keystone Petroleum (GKP) is an independent oil producer operating in the Kurdistan Region of Iraq and is listed on the Main Market.
GKP decided to undertake its own buyback programme as part of a strategy to return excess cash to shareholders and this included a dividend payment of USD 50 million as well as two share repurchase schemes of USD 25 million each.
At the time the return of cash was made, GKP had actually produced in excess of 50 million barrels of oil without a single cent ever being paid to shareholders; so, while this action was a welcome move, the share price at the time of writing trades at c. 75p, while the average buyback price was north of £2 per share. This of course illustrates the point that share buybacks do not always work as intended. Events do get in the way and the share price can fall.
Corporate actions
A share buyback is just one type of corporate action available to companies. To learn more about some of the more common corporate actions, please click here.
