(B) Open market
price is given. The company can also buyback its shares from the open market, just like any other investor. It has to announce its intent of the buyback, the duration, maximum price and the total amount that it will utilise for this purpose. Such offers can remain open for a long period of time or until the amount earmarked by the company's is fully utilized.

 

Why is this done?

 

   To support the share price: An overall weak market outlook can bring down the stock price substantially. In such a scenario, a management may decide to support the share price with a buyback to boost investor confidence. For example, after its three buyback programmes during FY09 and FY10

To fight the impact of equity dilution: A share buyback reduces the number of shares in circulation and hence is a great measure to fight equity dilution caused by events such as employee stock ownership plans (ESOPs) or bond conversion.

Increase promoters' stake: A buyback offer could be unveiled with a view to enable the promoter group to increase their stake in the company. Since the shares bought back are extinguished, those who are not participating in the offer will see their stake in the company's overall equity going up.

The Price Detector

When it comes to open offers, the Sebi has issued guidelines to determine the minimum price at which the open offer can be made. However, there is no upper limit. According to the Sebi rules, the highest between the average prices of the past 26 weeks and the past two weeks should be considered as the minimum price for an open offer.

   Buybacks are generally voluntary on the part of the company and, hence, there is no mandate on its minimum or maximum price. However, only when the company plans to delist its shares, a 'floor price' has to be discovered in line with the Sebi's guidelines.

   A reverse book-building process follows where retail shareholders can tender shares at any price higher than the floor price. The price at which maximum number of equity shares are tendered becomes the 'Discovered Price'.

   However, when it comes to how high an open offer or buyback price should go, it is the acquirer's need and financial ability that play a key role.

The Action Plan

An open offer or a buyback can be an exciting but temporary opportunity to make profit for investors. However, investors need to take an informed decision based on the intentions of the acquirer, the offer price and the company's future prospects.

   At the same time, keep in mind the fact that once the window of opportunity closes, the share price is likely to go back to its pre-offer levels.

   It is, therefore, important for investors to carry out a fundamental research on the company to identify its current fair value and expected fair value a year down the line. If the fair value in near future is likely to cross the offer price, one should hold onto his investments. It shouldn't, therefore, come as a surprise that in four out of six open offers, which are currently on.

   Another alternative for investors is to sell in the open market when the stock prices surge on news. An avid investor can actually fare much better by selling out in the market before the offer closes and covering back once the prices fall after the offer closes.

A Pitfall To Avoid

Investors must resist temptation to play the arbitrage game by buying in the open market after an open offer announcement and selling in the offer. This is risky since investors may get stuck up with a portion of their holdings, which will be worth much less in the market post-offer.

Even after an open offer is announced, the market price of the scrip tends to remain somewhat below the offer price, which one may regard as arbitrage opportunity. However, since the offer is for a limited number of shares, after the offer closes investors are likely to find themselves with a portion of their holding not accepted by the acquirer. If the market price crashes post-offer, the gains made in the offer are likely to get diluted or even negated.