The mosaic of share buybacks

WE recently reviewed 40 Malaysian listed companies and their share buyback strategy. Interestingly, all these companies bought back a minuscule number of shares, which to put it bluntly, seems completely senseless.

To try and understand what these companies were doing, we zoomed in to a particular Bursa-listed company to review its buyback strategy.

The first issue that struck us is that this company repeatedly takes the trouble to buy back its shares at least twice yearly, although the amount of shares bought back are insignificant. This puzzling strategy of buying very small numbers of shares back is also the same for the other 40 reviewed companies.

For instance, in 2008, the company bought a total of 10,500 of its shares at an average price of RM5.12 a share. This was sensible as its net asset value (NAV) per share was RM6.31 then. But last year, it bought back only 1,100 shares, and this time around, it paid a price that was 25% higher than the prevailing NAV. This caused its loyal shareholders to lose money, although one could say that the loss was negligible since the company repurchased only a few shares.

Then, in May 2010, the company launched another share buyback exercise and got back 5,000 shares at RM6 each. Now why would the company do all this? Well, for one thing, it could be trading like this so as to support its stock price of RM6 or more per share, especially if someone connected to its top management has a share margin account that needs to be “managed”.

If the company was not managing its stock price, why the need for it to conduct all these minuscule share buybacks?

Knowing that this company has been buying back only a few shares at a time, we asked its senior management why it persisted in buying back its shares when the share price was above the NAV. They told us that they were just following what their predecessors did from the time that they initiated share buybacks, which was after the company’s shares were below their NAV. Is the upshot that the company has continued the buyback exercises, albeit in minimal amounts, just to comply with its corporate tradition?

The management could not, however, explain the rationale for this strange buyback strategy or tell us if there was any existing regulation that compels a public company to carry on the scheme.

The thing about share buybacks in general, is that companies are rarely transparent about when and why it buys back its own shares. Such companies usually say that they do so when their shares are being traded below their intrinsic value, and so their buyback is aimed at enhancing share value for its stakeholders for the long term.

But is that really what it does?

To answer that, we combed through Regulation 18, Part IIIA of the Companies Act (1965) as well as Bursa’s Listing Requirements.

We noted that when a company decides to buy back its shares, it first has to issue a full-blown circular containing information on its solvency. Its directors also have to sign an onerous declaration of solvency prior to any such purchase of shares; they will first have to be convinced that a share buyback would be in good faith and in the company’s best interests. This is because a company can only use its distributable reserves to buy back shares, after seeking its shareholders’ approval at its AGM. The limit on drawing from such reserves is up to 10% of its issued and paid-up capital. After doing so, it is usual for companies to issue circulars at subsequent AGMs to renew such approval.

This all sounds reasonable on paper, but can be tricky in practice. To begin with, a company would need to start buying X amount of shares within seven days of declaring its solvency, because such a declaration is valid for only six months at a time. Plus, the company would need time to act on its plan, keeping in mind that it has up to a limit of 10% of issued and paid-up capital to buy back shares if there is a correction in its share price.

That has caused some companies to buy ridiculously small amounts of shares within seven days of declaring their solvency just to ensure the validity of that declaration, regardless of market conditions or share prices versus the NAV. The result is an inconvenience at best and unnecessary market activity at worst.

This is especially so since astute investors do not view such purchases kindly, especially if the buybacks are above the NAV per share. Some investors might even view such activity as the company’s way of propping up its own share price and, perhaps, even helping to “manage” the share margin account of a related party. This is where the regulators need to review the current framework that surrounds the share buyback option, which is clearly not in the best interest of all shareholders.

● Shireen Muhiudeen is managing director of Corston-Smith Asset Management in Malaysia, a fund management company that makes investment decisions based on corporate governance.