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Feb 17, 2017, 10.38 AM | Source: Moneycontrol.com

COMMENT: Do share buybacks of IT companies endorse mediocrity?

There is certainly pressure on IT companies to do their investors a good turn. But the question one needs to ask is whether share buybacks really help the company perform better in the long-term. The answer is a clear no.

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COMMENT: Do share buybacks of IT companies endorse mediocrity?

There is certainly pressure on IT companies to do their investors a good turn. But the question one needs to ask is whether share buybacks really help the company perform better in the long-term. The answer is a clear no.

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Shishir Asthana
Moneycontrol Research

When Tata Consultancy Services announced it will hold a board meeting next week to consider a share buyback, it was responding to popular calls made by investors that IT companies look for ways to give back excess cash to shareholders. TCS , which has a war chest of Rs 431 billion, isn’t alone. Earlier this month, Cognizant voted to award USD 3.4 billion to its investors over the next two years through buybacks and dividends.

There is certainly pressure on IT companies to do their investors a good turn. But the question one needs to ask is whether such share buybacks really help the company perform better in the long-term. The answer is a clear no.

A buyback impacts the share price, and not the company performance. As more shares are sucked out of the market, the value of the share increases. The amount of shares that will be bought back will decide the long-term benefit to the shareholder. A larger corpus for a buyback will mean that more shares would be extinguished. This would, in turn, improve the earning per share (EPS) of the company.

A share buyback does not change the ground reality that the sector is going through a bad phase. A buyback depletes the company’s arsenal to fight a slowdown as it uses up cash to buy its own shares.

A buyback also signals that a company is deprived of ideas for growth since it is unable to utilize its cash. Although IT companies hold pride of place on Indian bourses, they are at the lower end of value addition in the entire IT firmament. None of our companies find a mention in the global debate about path-breaking organisations. The reason is simple: Our companies mostly end up providing the support function or coding jobs for larger companies.

Now, there is a big opportunity to move up the value chain.

Since companies are wary of large acquisitions, the only way to climb up is to get into product, consulting and digital spaces by themselves. This would require risk capital. Rather than sitting on idle cash Indian companies could motivate themselves to think out of the box.

But what is holding back IT companies from taking the plunge are conservative shareholders. Instead of giving the companies a long rope and allowing them to test new avenues, shareholders are asking them to return their cash back. The cash that has been accumulated by IT companies are after paying a handsome dividend .

With such a mindset it would be impossible for an Indian company to be a Google or a Tesla where every idea is encouraged and allowed to reach a logical conclusion. The only reason Google and Tesla are where they are is because shareholders in the US encourage research and development and permitted them to use the company’s cash pile.

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COMMENT: Do share buybacks of IT companies endorse mediocrity?

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