Moneycontrol Pro Panorama | Propping up valuations through buybacks no substitute for good performance

Representative image.

Dear Reader, 

The Panorama newsletter is sent to Moneycontrol Pro subscribers on market days. It offers easy access to stories published on Moneycontrol Pro and gives a little extra by setting out a context or an event or trend that investors should keep track of. 

Do the hard work and rewards will follow is one philosophy of life. But many scoff at that, believing other factors determine rewards, such as luck, timing and so on. In the stock market too, sometimes there’s a huge gap between owners/managers and the Street on the valuation ascribed to the business. Paytm’s decision to buy back shares too appears to be one more effort by listed startups trying to support their fallen share prices.

Many of these startups listed when valuations were booming and PE/VC investors accurately called the top, although IPO investors were left holding the can. And, when the 1-year lock-in for pre-IPO investors ended, a selling spree saw shares fall further in anticipation of a coming flood of share sales. That saw some startups announce bonus shares. Nykaa’s bonus shares and then a modified record date that made it difficult for shareholders to sell after the lock-in expired also caused controversy. The fundamentals too did not justify the bonus, as we had pointed out recently.

Another time-tested option to return money to shareholders and shore up valuations are buybacks. While there are legal conditions to be met, such as debt to equity not exceeding certain limits and a time-gap between two buybacks, from a financial standpoint some conditions are good to have. The business should have matured to a level where the cash required to grow the business in the long run is less than the surplus being generated. If a company’s stock is undervalued, then by lowering the equity and net worth, valuations could get some support. And, buying back shares at a significant premium to the price can send a signal to the market. Although share prices could well fall back to the pre-buyback level once the process ends, especially if the underlying ills causing low valuations are deep-rooted.

Paytm’s share price is already up by 6 percent at noon, although details about the quantum and price per share will be known after its board meeting on December 13. But Paytm does not really fit the qualification of a matured business. IT majors can claim to be in this category, explaining why they are regulars on the buyback circuit. Paytm’s cash flow statement shows it has seen an outflow on the free cash flow from operations front (net cash from operating activities less fixed asset investments) of Rs 162 crore in the half year ended September 30. However, it does have sizeable cash on its books: Rs 1908 crore in current investments and Rs 5237 crore in cash and bank balances.

But these monies, some of which came from its IPO, are seen as sources to be deployed to fund business expansion plans. While startups may have turned a bit cautious in the current environment, it will be a matter of time before they will invest to grow the business or respond to competition. A focus on profitability may lower cash requirement now but that may not be the case forever. However, buybacks mean cash flowing out and if the business requires more cash, then that could mean raising fresh equity. It would appear that the buyback is more of a tool to support valuations. The size of the buyback and price will give a clearer picture of what the management is seeking to achieve.

The broader question remains of what is the right time for a company to buy back shares and whether company managements should be taking a view on the stock price at all. Done for the right reasons, a buyback is a useful tool to return cash and improve valuations. But if the sole purpose is to prop up sagging valuations then it’s a sub-optimal one. It’s better to address the underlying issues resulting in the share price underperforming. That can give an upward and more lasting push to valuations compared to the temporary sugar rush a buyback can provide.

Investing insights from our research team

Weekly tactical pick: Campus Activewear poised to improve earnings

Sirca Paints: Great progress on all fronts

Balrampur Chini Mills: Preparing for the next growth phase

What else are we reading?

Personal Finance: Who needs a travel budget anyway? 

Gig is big in jobs — Is the shift transient or permanent?

Banks shouldn’t ask for tax breaks, but sell more in the countryside

How farmers can grab a bigger slice of the agriculture value chain

The emerging contours of US-China hegemonic competition

BJP’s outstanding win in Gujarat overshadows the Himachal and Delhi MCD reversals

Macro signals for sector-allocation and the other way around

Storage is one of the least sexy words around. That’s a problem (Republished from the FT)

Fininfluencers | Existing regulations enough to rein in fraudsters

Dissent is not disloyalty. Employers must accept this — the earlier the better

Why have Gujarat and Himachal Pradesh responded differently to Narendra Modi's appeal?

Technical Picks: Federal Bank, NMDC, Navkar Corporation, and ICICI Bank (These are published every trading day before markets open and can be read on the app).

Ravi AnanthanarayananMoneycontrol Pro