Buyback best way to use cash, not bonus: Ex-Infosys CFO Pai

Also read: Prof CEO deserves a pat, says 'average Joe' NRN Murthy

The company shareholders must question the new management on how they choose to spend the extra money.  The company shouldn’t let the money stay in its balance sheets as the management is likely to succumb to pressure and make large acquisitions, adds Pai.

Below is the edited transcript of Mohandas Pai's interview with CNBC-TV18's Menaka Doshi and Senthil Chengalvarayan.

Menaka: Are you happy with the bonus instead of a buyback?

A: I think they are two different issues. Buyback was proposed to make sure that you deal with excess cash in the balance sheets. About 25 percent of the operating profits of the company are coming from return on bank deposits and that is not an acceptable situation.

It is making the management extremely complacent because you have so much cash in the balance sheet that you don’t have to earn so much of returns because it is just coming as interest. It is creating possibly a less dynamic company.

Whenever a company has huge amounts of cash in the balance sheet, 60 percent of revenues or whatever it is like Apple has may be USD 133 billion, Infosys has about Rs 32000 crore of out of Rs 55000 crore revenue, Microsoft had about USD 80 billion at one point of time, at that time investors had asked them to buyback the stock even if the stock price remains high because they want an efficient use of the cash.

It is very tempting for management with so much of cash to look at blockbuster acquisition because they will be under pressure from analysts to do much better. The market is not against them. They will try to do acquisitions at very fancy prices. None of the large acquisitions in history have ever worked. So, it is very important to look at cash in the balance sheet separately from a bonus issue.

What does a bonus issue do? A bonus issue enhances liquidity, reduces the entry price for investors and people hope that because of enhanced liquidity more and more small people will buy and the market will become more vibrant. It is not necessarily a great strategy because Berkshire Hathaway has never had a bonus issue even though they had Baby Berk in place. It doesn’t add value it splits the capital into smaller units for greater liquidity and beyond that it does not do much.

If you look at Apple again, Apple did a stock split brought down the share from USD 700 to USD 100 or less because they said that we wanted to be more affordable to people to buy 1-2 shares and now they have announced a USD 98 billion buyback. So, these are two different things. Apple is doing well, it is still growing at 15 percent, has got USD 50 billion of net income. So, these are two separate issues which have to be tackled separately.

As far as we are concerned I think we sent it when the stock price was Rs 3200 and said the buyback should be around Rs 3800. The stock price has crossed Rs 3800 so everybody is happy but the issue of excess use of cash still remains and for that you pay it back as dividend, you make an acquisition, you keep in the balance sheet and earn dumb revenues or you give it back to shareholders. That is a debate the board has to do and give an answer to shareholders.

Senthil: Isn't paying a dividend on an enhanced equity base which comes about by a buyback as good as giving cash back to shareholders more?

A: No, it is not because the dividend is not tax-efficient. You have to pay 18-20 percent tax on that and that is a one-time event and it is forgotten. This is not yield stock. Dividend is a nice thing to have for a growth stock because the dividend yield is 2 percent. The 2 percent is not going to make a much difference to people who hold the shares in rupees. People who hold in dollars 2 percent may buffer them against any foreign exchange fluctuations but the people who hold in rupees, for them 2 percent makes not much of difference even though for some of them it does give them a large revenue but how much dividend will you pay? You are already paying 40 percent.

A buyback reduces the share count totally, the EPS goes up because of that. If you look at even Cognizant, Cognizant has been doing a buyback, they made an acquisition with cash but they have had 2 or 3 buybacks. Buybacks are a very efficient way of managing capital and allocating capital especially when you have surplus capital in the balance sheet.

I want to make another statement which is a very important statement. When a company matures, starts getting steady revenues, gets annuity income and is growing reasonably well, whatever rate it is then the question of capital efficiency arises, capital allocation arises.There are innumerable case studies to say buybacks have enhanced return on equity, enhanced market value for all investors and made companies more efficient. India Inc has to look at it seriously because many companies are maturing and have become very large companies.

Menaka: From a tax efficiency point of view, at least from the shareholders point of view dividend is more tax efficient or less tax burdensome than a buyback would be right? If you keep the shareholder at the centre of this and try and look at it from the point of view of how the shareholder stands to benefit between the two.

A: There is no distinction between the shareholder and the company. In a dividend the company pays the tax, the shareholder doesn’t pay the tax but the company is paying the tax out of the shareholders money. The profit belongs to the shareholder.

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In a buyback, you buyback in the market and reduce the share count, you are not paying much tax. Anybody who wants to sell, shareholders don’t have to sell, they can buy it from the market, there will be some sellers there who want to get out and you buy from them reduce the float and that is very important. Shareholders don’t loose anything. So, I think we got to be careful about this distinction because this distinction is not the right distinction.

Menaka: Are you going to maintain or continue your agitation for a buyback?

A: No, this is not an agitation. What Bala and I have done as good corporate citizens, as shareholders of a company is to raise the bar for corporate governance and it is very important for India. There is a company in India which has got nearly Rs 100,000 crore of cash, one of the largest Indian company, somebody should ask them what are you going to do with this cash and they generate Rs 25,000 – 30,000 crore cash every year. The time has come for investors to stand up and ask company management what are they doing with excess cash in the balance sheet.

For example Coal India has got Rs 60,000 crore of cash, government should take it out and give it to shareholders instead of keeping it at the bank at 8 percent. Hindustan Unilever Limited (HUL) has got Rs 25,000 crore of cash, you have got National Mineral Development Corporation (NMDC) with Rs 18,000 crore as cash. Many of them have them have got cash and then they are not using the cash, there is no investment plan for the cash. So the cash has to come back, it has to be recycled. Keeping in the balance sheet is not a proper incentive for everybody.

So we are raising the bar, putting all these issues and the best place for put the issues is Infy which is known for corporate governance, hopefully the board should debate it and give us a technical reason how they are going to use the cash. I had been away from the morning so I have not heard what the management has said about the technical reason. What do they propose to do with the cash.

Menaka: Vishal Sikka did not say that a buyback was off the table he just said that we are still a relatively new management so we are going through the rationale regarding a buyback. He also made some comments on inorganic growth indicating that he might be looking for entities to buy or businesses to buy specifically in the artificial intelligence or automation areas which has been a key thrust area in all of his commentary today but I imagine those will be not very large entities. They will be more technology focused, small sized acquisitions. So, this USD 5 billion cash that we are talking about is unlikely to fully get consumed by any such inorganic strategy over the next couple of years.

A: This is exactly the case. We have a new CEO, he is a very good person. He comes from the enterprise side and he probably has a bigger view of the enterprise rather from the project side which is what management is about but the board remains the same. Many of the board members have been there for 10 years, they know the cash, it is a service company. A service company throwing up USD 2 billion of cash a year, with USD 5 billion, with no debt in their balance sheets, no investment plans, I mean this is dumb. They must answer this question.

Senthil: Sajeet has a point when he says that a buyback can only be 10 percent.

Menaka: That is only a procedural thing, if you don’t want to go to shareholders for approval. You can go to shareholders. I am sure shareholders are not going to disapprove of a buyback plan if they feel that will improve stock price, put the cash to better work and all of that.

A: I want to make another point. Management in every company is under pressure from analysts all the time. Raise the revenues, give us better Earnings per share (EPS), take their target up and everything like that. Now management should not succumb and we have not succumbed to this for the last so many years where Bala was there, I was there till now. There is a new management and Mr Murthy was there and Mr Murthy was a person who was very clear what has to be done he will safeguard the asset, but you must not succumb to a large acquisition just because in one quarter you don’t do well, I hope it doesn’t happen, just because analysts put pressure on you.

The managements are susceptible. You look at the corporate history everywhere and they can blow up the cash. This is a very great issue which has to be decided, which has to be debated. That is why I want the board to tell the shareholders what do they want to do with the cash, not make vague statement that this is a new management. Yes, there is a new CEO but the board remains the same, the board matters. The chairman and the board has to tell the shareholders here is a request come from the shareholders, what is your point of view and more than that what are you going to do with the cash in the next one year.Sajeet: Sikka has nearly 2 years to come to the growth levels of 15 percent which is the industry growth levels. Shouldn’t he be keeping the buyback option towards the end of the two years if he is not able to meet the growth target of nearly 15 percent of industry growth rate? If he is going to come out with a buyback now for the next one and half years you can't come back with another buyback if he is not able to meet the growth targets.

A: When you have a new management you must put their feet to the fire and ask them to grow and not give them options of a bailout in case they don’t perform well. You got a new management, you are paying a very high salary and you must set them high targets and make them work hard. You are saying that I am going to give you a bailout, keep everything ready for a bailout in case they don’t do well, what kind of strategy is that?

In case they don’t perform and get those targets they should be sacked. That’s the right way to treat management because shareholders interest comes first. This is exactly the point I am making, the cash is creating comfort. If we reach 15 percent great, if we don’t we will buyback and we will do this. We are very comfortable, it doesn’t matter whether we fail or we do well because we got this cash, we are very comfortable. That comfort should not be there. They must be paranoid, they must be working hard 24x7, growing the revenues, running up and down, getting the team in action, that is the history of this company. Murthy has driven everybody 24x7, up the target every single time.

Menaka: That means that today if the shareholders are delighted with the bonus you are telling them hold on to your cheer because what you should actually get is a buyback?

A: All I am tell is you need an answer on how the cash is going to be used by the management. Whether it is buyback otherwise one time dividend that the management gives, I need an answer.

Menaka: You are not happy enough with the bonus, is it?

A: Let me tell you a secret. We wrote to Mr Murthy again and we told him that, look, the stock price has reached Rs 3,800 which was what we had recommended. Now you are stepping down and the founders are transitioning. Why don’t you look at a bonus at a large one time dividend as a farewell to the shareholders because there is a change of generation and a new management team without any of the founders and an old team has come in. So as a parting thing, to tell shareholders you love them and you have respect for them give them something as an indication and Mr Murthy listened and the board has gone along with that bonus issue which is a good thing. But remember bonus doesn’t create any value. It enhances liquidity but it is nothing.

But the question you must ask is what are you doing with the cash, give us a definite answer. Don’t say give us more time, I need another one or two years. In one or two years Rs 32,000 crore may go to Rs 50,000 crore because it is a cash engine and if you get 25 percent operating revenue coming from interest on bank deposits getting you 5.5 percent it is a wastage of capital.