SINGAPORE (Jan 14): Last year, the Straits Times Index lost 10.5%, owing to a range of global and domestic factors. Amid the plunge, many locally listed companies took the opportunity to buy back their own shares.
According to SGX My Gateway, the Singapore Exchange’s investor education portal, the value of share buybacks more than trebled to $1.53 billion in 2018, from $426 million in 2017. The figure was also higher than the $826 million worth of share buybacks recorded in 2016, but lower than the $2 billion worth of share buybacks registered in 2015.
The share buybacks were conducted by 100 Mainboard-listed companies, according to SGX My Gateway. About 80% of the shares in terms of value were bought by STI constituent companies, such as CapitaLand, DBS Group Holdings, Oversea-Chinese Banking Corp, United Overseas Bank and Keppel Corp. Compared with their combined market value as at end-2018, however, the value of the share buybacks was “small change”, SGX My Gateway says.
Companies buy back shares for different reasons, but they usually revolve around the efficient allocation of capital in the light of market volatility. According to one investment banker, share buybacks typically occur when companies have excess cash and their shares are deemed to be undervalued. This excess cash could be the result of a lack of investment opportunities or other corporate purposes. Rather than letting it become idle, companies may choose to reduce their paid-up capital.
“The Singapore market has been trading quite low. So, companies think their shares are undervalued,” he tells The Edge Singapore. “When investing opportunities are limited, share buyback is one way to utilise the excess cash.”
Says another investment banker: “It is [also] an indirect way of returning money to shareholders,” To that, many shareholders will retort: Why not give out the excess cash in the form of higher dividends?
According to the second banker, companies may prefer to conduct share buybacks rather than pay more dividends because the latter creates an expectation of at least committing to a new payout level. “But perhaps this could be a one-off,” he says. “By buying back the shares, the expectation is not there — that they will continue to buy in the future.” If shareholders expect dividends, they would often expect companies to have in place a dividend policy for an additional layer of assurance.
In addition, companies may conduct share buybacks to provide share schemes to their employees. Shares bought are converted to treasury shares, which in turn are awarded to deserving staff, the second banker adds.
Higher value of US share buybacks
To be sure, the rising trend of share buybacks is not unique to Singapore. In the US, the value of shares bought by companies surpassed US$1 trillion ($1.36 trillion) in mid-December for the first time in a calendar year, according to Barron’s.
Since 2009, share buybacks there have totalled as much as US$4.5 trillion, according to a recent report from the DBS Chief Investment Office. Technology companies accounted for the lion’s share of buybacks: 31% in 2Q2018 and 51% in 3Q2018, it notes. Most notably, Apple bought back a whopping US$73 billion worth of shares in its latest financial year ended Sept 29, 2018. Besides Apple, other US technology companies such as Microsoft and Oracle have spent billions buying back shares. Financial, healthcare, industrial and consumer discretionary companies have been active too. “Share buybacks in the US have been on a tear since the subprime crisis,” says the report.
The reasons for the spike in US share buybacks are similar to the share buybacks in Singapore. As US corporates record higher earnings and free up more cash, they could deploy the cash for either dividend payouts or share buybacks, after accounting for capital expenditure and mergers and acquisitions (M&A), notes DBS Chief Investment Office.
Most company managements would opt for share buybacks, it says, because the benefits from capex or M&A usually do not show up immediately, owing to a gestation period. Share buybacks also provide management with as much “flexibility”, unlike dividends, which commit the company to a certain dividend payout. It would be difficult to backtrack from that “level of commitment”, DBS Chief Investment Office says.
Regulator is watching
The debate between share buybacks and higher dividends is ongoing, but the growing trend of the former by SGX-listed companies has caught the attention of the exchange. In its Nov 26, 2018 Regulator’s Column by Singapore Exchange Regulation (SGX RegCo), its CEO Tan Boon Gin warns companies not to abuse share buybacks. This is because share buybacks could have a “significant” impact on the price and volume of a security traded on an open market. The impact could also extend over a considerable period in the light of the share buyback mandate.
As a result, this could harm the market. “If the price and volume of a security have been artificially interfered with through share buyback activities, the investing public would be misled and deceived as to the genuine market value of the security. This will undermine the operation of a fair, orderly and transparent market,” writes Tan.
While he acknowledges that share buyback serves as a “useful capital management tool” and is a “legitimate commercial activity”, it is subject to relevant market conduct provisions of the Securities and Futures Act. As such, any breaches in the SFA will lead to regulatory action.
For one, Tan says, a company can be construed to be involved in insider trading if it undertakes share buybacks during periods when it is in possession of inside information. This is because a company is considered a “legal person” and therefore subject to the law, including the SFA.
To avoid all doubt, SGX RegCo has advised companies to refrain from performing share buybacks when there are material developments or unannounced material information that may have an impact on the company’s share price or trading volume. They should refrain until such inside information has been publicly disclosed, it says.
“The Listing Rules do not expressly prohibit a company from buying its own shares during any particular period. As best practice, however, a company should refrain from carrying out share buybacks during the two weeks immediately preceding the announcement of its quarterly financial statements and one month immediately before the full-year financial statements,” says Tan in his column.
For another, SGX RegCo notes that companies can be construed to be involved in creating a false market. This can occur when they conduct share buybacks near or at the market close, thereby influencing the closing prices of their own shares. Tan describes a scenario in which companies place orders for as little as 300 or even 100 shares near or at the market close, “which would hardly make any dent in any capital management programme”.
This could also happen when companies initiate share buybacks despite increasingly higher prices. SGX RegCo says it views such actions as being executed for the likely purpose of influencing the closing price as opposed to being bona fide purchases.
Warning against market misconduct
That aside, excessive share buyback activities — for instance, purchases that exceed 30% of the daily on-market traded volume — may result in the artificial inflation of the trading volume and price of the security.
“This means that like any other trading activity, share buybacks should not be used to carry out any form of market misconduct such as insider trading or creating a false market,” writes Tan. “Such misconduct is illegal and, if SGX RegCo suspects such an activity is taking place, we can intervene, such as working with our members to stop any attempt at further wrongdoing and issuing a ‘Trade with Caution’ to alert the public to the findings of our investigation, if necessary.”
Asked whether SGX RegCo was investigating any cases of share buyback misconduct, a spokesperson declined to confirm. In any case, if company insiders had wanted to flout the rules, some would have done so via other means.
According to SGX RegCo, 37 cases of insider trading were escalated to the higher regulator, the Monetary Authority of Singa-pore, during SGX’s FY2018 ended June 30, 2018. In the previous year, there were 20 such cases. Meanwhile, the number of market manipulation cases halved from 14 to seven between FY2017 and FY2018. More recently, there were two cases of insider trading and four cases of market manipulation that were referred to MAS in 1QFY2019.
So, what should investors do if the company that they are invested in conducts share buybacks? Alfred Chia, CEO of SingCapital, says they need to be careful by doing their homework. “Investors should analyse the intent and effect of such buybacks, and not join in the speculation or [get] misled,” he says.
Assuming that the share buybacks are legitimate, however, they could present opportunities for investors. As share buybacks reduce the number of shares outstanding, earnings per share and return on equity will be enhanced, says a lawyer who specialises in capital markets. Share buybacks also indicate that the valuation of a stock may be attractive to accumulate, says the first investment banker. “[Ultimately], the golden rule for investors is still to focus on the fundamentals of the company, and the right valuation will be reflected,” says Chia.
