AFMP4
Syllabus D. Corporate Reconstruction And Re- Organisation D2. Business re-organisation

D2ab. Share repurchase 6 / 7

Syllabus D2ab)

a) Recommend, with reasons, strategies for unbundling parts of a quoted company.

b) Evaluate the likely financial and other benefits of unbundling.

Companies may purchase their own shares back

Therefore if a company has surplus cash and cannot think of any profitable use of that cash, it can use that cash to purchase its own shares.

Share repurchase is an alternative to dividend policy where the company returns cash to its shareholders by buying shares from the shareholders in order to reduce the number of shares in issue.

So what will actually happen?

  1. The company's CASH will go DOWN.

    Becasue the company is buying the shares back.

  2. The number of SHARES will go DOWN.

The effect on EPS

EPS = Earnings / Shares

  • Earnings will stay as they are

  • But you will have less shares

  • Therefore EPS will INCREASE

Shares may be purchased either by:

  1. Open market purchase – the company buys the shares from the open market at the current market price.

  2. Individual arrangement with institutional investors.

  3. Tender offer to all shareholders.

Reasons for share repurchase

  • Readjustment of the company's equity base

  • Purchase of own shares may be used to take a company out of the public market and back into private ownership.

  • Purchase of own shares provide an efficient means of returning surplus cash to the shareholders.

  • Purchase of own shares increases earning per share (EPS) and return on capital employed (ROCE).

  • To increase the share price by creating artificial demand.

Problems of share repurchase

  1. Lack of new ideas

    Shares repurchase may be interpreted as a sign that the company has no new ideas for future investment strategy. 

    This may cause the share price to fall.

  2. Costs
     
    Compared with a one-off dividend payment, share repurchase will require more time and transaction costs to arrange.

  3. Resolution

    Shareholders have to pass a resolution and it may be difficult to obtain their consent.

  4. Gearing

    If the equity base is reduced because of share repurchase, gearing may increase and financial risk may increase.