COMMENT: Why buybacks for IT companies is a bad idea

Shishir AsthanaMoneycontrol ResearchWith US President Donald Trump trumpeting his call for protectionism at the drop of a hat, Indian IT companies as well as investors are going through anxious moments. Now, shareholders of companies in the USD 147-billion sector think they have finally got some reason to smile.Reports say that institutional investors are asking IT companies to announce a liberal buyback policy. But the fact is, though such a policy is good for investors, it is not necessarily so for a company.When Warren Buffett advocated buybacks his reasoning was different than those of the present set of institutional investors. Buyback as a mode of rewarding shareholders is a more tax-efficient way in which short- term and medium-term investors are dislodged. The long-term investors gain as the equity base shrinks. The promoters gain as their stake in the company increases.Coming back to the IT sector, the current issue is of companies sitting on a pile of cash but being reluctant to expand or invest in growth due to poor visibility. What the institutional shareholders are saying is this: Give us our money back if you are lacking growth ideas.Normally, buybacks are considered as a sign of optimism on the company’s part. Buybacks are generally done when the company feels that its share price is below its fair value.But forcing a company to announce a buyback because the stock is underperforming is misusing the instrument. There may be acquisition opportunities out there as a tough environment leads to distress sales.The top four IT companies have nearly USD 16.95 billion between them. CNBC-TV18 reported that Infosys was considering a Rs 12,000-crore buyback, which is around 5.5 percent of its market value. The amount is nearly one-third of Infosys’ cash balance of around Rs 34,000 crore.This is not the first time that Infosys or other IT companies are facing buyback requests. In 2014 Infosys faced a similar request from its ex-chief financial officers V Balakrishnan and TV Mohandas Pai and board member DN Prahlad, who asked for a Rs 11,000 crore buyback. Rather than obliging with a buyback Infosys announced a bonus issue of shares in April 2015. The bonus issue has not helped the share price as it currently languishes around the same level at which the bonus shares were issued.Since 2014, outlook for IT has only turned gloomier. Announcing a buyback now would act only as a temporary pain killer and deplete cash which could have been used to acquire companies or fuel future growth.Infosys’ CEO Vishal Sikka has maintained that the company would be a USD 20 billion company by 2020, nearly double from the current levels. The only way he could do it, given the current growth rate, would be through big acquisitions. A buyback might prevent him from reaching those levels.It’s for the shareholders to decide if they want long-term growth in the company or short-term share market gains. Our vote is for long-term growth.