Abstract
This case discusses the share buyback announcement by Tata Consultancy Services (TCS) during February 2017 when its Chairman N Chandrasekaran was appointed as the Chairman of Tata Sons after Tata Sons had ousted its former Chairman, Cyrus Mistry. The case highlights the reasons why companies may opt for share buyback, what is the role of the tax laws of the country towards these decisions and whether such decisions are beneficial for the company, the investors or the promoters. The case considers impact of aspects such as employee training and investments in innovation on the buyback decisions and also brings an international perspective with regard to how buybacks have fared in the US during the past decade.
Introduction
The present case discusses the share buyback announcement process by Tata Consultancy Services (TCS) during February 2017 when the managing director of TCS was also appointed as the chairperson of Tata Sons. Formed in the year 1968 by Tata Sons, TCS grew to become one of the most valuable companies in India and the top contributor to the earnings of Tata Sons.
The case highlights the reasons why companies, such as TCS, may opt for share buyback and whether such a decision impacts the investment options the company might otherwise pursue with the same cash and resources. The case discusses how tax laws impact buyback decisions and brings an international perspective with regard to how buybacks have fared in the USA in the past decade.
The Buyback Decision at Tata Consultancy Services
On 20 February 2017, few days before leaving TCS, a leading information technology company in India, its CEO and Managing Director N. Chandrasekaran got the board of directors of TCS to approve the decision to buy back shares worth ₹160 billion (USD2.37 billion at ₹1 = USD0.014827). In few days, N. Chandrasekaran was leaving TCS to join Tata Sons 1 (the parent company of TCS) as its chairman. On 20 February 2017, he was wearing two hats, the CEO, MD, of TCS and the chairman designate of TCS and the chairman designate of Tata Sons.
The board of TCS approved the buyback at the share price of ₹2,850 (USD42.25) per share, a premium of 13.7 per cent of its price on 20 February 2017 (Rukhaiyar, 2017). This was the biggest buyback in the history of India’s capital market, surpassing Reliance Industries’ share repurchase of ₹104 billion (USD1.54 billion) in 2012 (Aggarwal, 2017). TCS share price rose by 4 per cent to close at ₹2,506.50 (USD37.16) on the Bombay Stock Exchange (BSE) on the day of the announcement. However, the stock lost nearly 1 per cent to close at ₹2,481.65 (USD36.78) on 23 February 2017, taking the buyback premium to almost 15 per cent over the price on that day.
Back in 2011, Ratan Tata 2 and the board of directors of Tata Sons had picked Cyrus Mistry to be the chairman of the Tata Sons. However, by 2016, Tata Sons thought that Cyrus Mistry was not the right choice (Kalesh, Vijayraghavan, & Barman, 2016) and the board, in an unprecedented step, ousted Cyrus Mistry and appointed Ratan Tata, as the interim chairman for 3 months. During the interim period, the board searched and decided to appoint, on 12 January 2017, N. Chandrashekaran, the serving CEO of TCS since 2009, to be the chairman of Tata Sons (Philip, 2017).
In the buyback, TCS was buying back shares that accounted for around 2.85 per cent of the total paid-up equity capital of the company. The buyback was being made through the tender offer route, which meant existing shareholders would tender their shares through the stock exchange. Tata Sons, the parent and promoter company of TCS, held 73 per cent in TCS. Of the 27 per cent public shareholding, 22.24 per cent was held by institutions with LIC being the largest (3.44%). The balance was held by non-institutions and retail shareholders where former Tata Sons Chairman Cyrus Mistry held over 11.4 million shares, representing over 13 per cent of TCS’s non-institutional public shareholding (Zachariah, 2017).
On 20 February 2017, TCS had nearly ₹43,100 crores (USD6.388 billion) cash on its books which was nearly 9 per cent of its market capitalization (Mudgill, 2017). The Securities and Exchange Board of India (SEBI) rules allowed a company to buy back shares of up to 10 per cent of its total net worth without shareholders’ approval and up to 25 per cent with shareholders’ nod.
Tata Sons filed a regulatory filing at the BSE of its intent to participate in the buyback process of TCS. According to Dipen Shah, Senior Vice President-Research, Kotak Securities, by participating, Tata Sons wanted to reduce their shareholding which otherwise would have gone up further (Mandavia, 2017).
The size of the buyback was substantially significant compared to the payouts of TCS during the 6 years between 2011 and 2016 when TCS had paid about 43 per cent of its profit back to the shareholders in the form of dividends (Philipose, 2017). After taking into account the buyback, the total payout during the period 2010–2017 amounted to about 54 per cent of the profits (Aggarwal, 2017; Figure 1).
Growth of Tata Consultancy Services
Tata Sons Limited formed TCS in 1968 (Forbes, n.d.). One of its early contracts was punched card services to another Tata Sons company TISCO (now Tata Steel) and providing reconciliation services to the Central Bank of India (Tata Consultancy Services, 2017).
By 1975, TCS had expanded its services and its clients to include Swiss company SIS SegalnterSettle, Canadian Depository System X and the Johannesburg Stock Exchange (Swissinfo, 2002). By 1980, TCS had established India’s first dedicated software research and development centre, the Tata Research Development and Design Centre (TRDDC), in Pune. Before 2000, TCS had created the factory model for Y2K conversion and developed software tools to automate the Y2K bug conversion process and enabled third-party developer and client implementation.
In August 2004, TCS became a public-listed company. By the end of 2008, its e-business activities were generating over US$500 million in annual revenues. TCS started to service the small and medium enterprises market for the first time in 2011, with cloud-based offerings (Computerweekly.com, n.d.). On the last trading day of 2011, it overtook Reliance Industries Limited to achieve the highest market capitalization of any India-based company. By 2015, TCS was ranked 64th overall in the Forbes World’s Most Innovative Companies ranking, making it both the highest-ranked IT service company and the top Indian company (Forbes, n.d.).
By 2017, TCS provided IT services, consulting and business solutions to organizations and offered a consulting-led, integrated portfolio of IT, business process outsourcing (BPO), infrastructure, engineering and assurance services (Tata Consultancy Services, n.d.). TCS helped clients from various industries such as banking and financial services, energy—oil and gas, oil field services and renewable services, government, healthcare, high tech, insurance, life sciences, manufacturing, media and information services and resources—metals, mining and construction, retail and consumer products, telecom and travel and transportation and hospitality (Tata Consultancy Services, n.d.).
As of May 2017, TCS had over 371,000 IT and other consultants in 45 countries and 208 offices across the globe. During the financial year 2015—2016, the company generated consolidated revenues of US$16.5 billion and a market cap of US$71.6 billion as in May 2017. The company was listed on the National Stock Exchange and BSE in India (Tata Consultancy Services, n.d.) (refer to Tables 1 and 2).
Financial Summary of TCS for the years March 2007–March 2017
Quarterly and Annual Financial Performance of TCS during 2011–2016
By May 2017, TCS (market capitalization of US$70.69 billion) was the most valuable company in the Tata Sons’s group of companies followed by Tata Motors (US$20.52 billion), Titan (US$6.61 billion) and Tata Steel (US$6.75 billion). In all, the top five companies accounted for more than 90 per cent of the group’s market value (Market capitalisation of Tata companies as, 2017). TCS was one of the major contributors of dividends to the Tata Sons. During the financial year 2015–2016, TCS provided a dividend close to ₹64,000 million (USD0.948 billion) to Tata Sons (refer to Table 3).
Dividend Provided by TCS to Tata Sons during 2007–2016
Was Buyback Essential for Tata Consultancy Services?
Companies buy back their shares due to various reasons. These reasons could be that the company had too much cash on its books or the income tax regulations favour buybacks rather than dividends as a means to reward the investors. Other reasons included boosting the earnings per share (EPS) or management signalling.
One of the most prominent reasons companies bought back their shares was due to large cash surplus in their balance sheets. Too much cash on the balance sheet was not considered financially healthy showing inefficiency in the utilization of assets. TCS, as of 20 February 2017, had a cash pile of nearly ₹431 billion (USD6.388 billion). During the financial years 2011–2016, most of the Indian IT companies had large cash balances on their books (refer to Table 4).
Cash and Cash Equivalents in Information Technology Companies during 2011–2016
Large cash balances meant that the companies did not invest in R&D to grow their capacity or invest to grow inorganically through acquisitions. Since several IT companies had large cash balances, analysts indicated that the investment for transforming the industry from purely cost-arbitrage operations to creating intellectual property had not happened. Research showed that most IT companies had spent less than 2 per cent of their revenue on R&D. The R&D and innovation expenditure of TCS, as a percentage of total turnover, declined from 1.12 per cent during 2013–2014 to 0.96 per cent during 2014–2015 (Press Trust of India, 2015). As a percentage of total income too, it remained substantially low (Table 5).
Tata Consultancy Services Ltd Expense Details: March 2007–March 2016—Non-annualised (₹ million)
According to the CEO and Managing Director of Infosys, S. D. Shibulal, to grow inorganically, IT companies had to invest in acquisitions, even if it involved large investments (Mishra, 2013). TCS did few acquisitions, starting its inorganic growth in 2003 by bringing Swissair’s 75.1 per cent stake in Airline Financial Support Service India (refer to Table 6). However, most of the investments were of smaller ticket size.
TCS Mergers and Acquisitions Summary
Another reason companies had started looking at buybacks compared to dividend payments was the changes in the income tax rules regarding buyback. In India there was no additional tax on buyback; however, there was a dividend distribution tax of more than 20 per cent on the companies while individuals had to pay 10 per cent tax if dividend received was more than ₹1 million (USD14,822) (PressReader, n.d.). Companies wanted to reduce some of their dividend liabilities by buying back shares and reducing dividend cost.
Increase in the overall EPS was another reason for companies to do buybacks. In a buyback, EPS improves as the number of shareholders gets reduced while the fundamental value of the business remains unchanged. This improved EPS impacts other accounting measures such as return on equity and puts pressure on peers in the industry. For example, in the IT industry, TCS followed Cognizant’s US$3.4 billion February 2017 buyback plan and Wipro and Infosys shareholders too demanded buybacks to protect the shareholder interest. In HCL Technologies, the country’s fourth-largest IT company, shareholders also considered the proposal for buyback of shares during its shareholder meeting (Bureau, 2017).
Are Buybacks Beneficial for Investors?
Buybacks in India happened through two routes, through the open market (book building or stock exchange) where only public shareholders could offer their shares for buyback and another by buyback through the tender offer through stock exchange, where both the promoters and public shareholders offer their shares. If shares were bought directly, short-term capital gains were paid on the basis of slab rates and long-term capital gains were taxed at 20 per cent with indexation and 10 per cent without indexation. However, in case of buybacks through stock exchange or through tender offer, a security transaction tax (STT) had to be paid and was entitled to exemptions from the long-term capital gains under Section 10(38) of the Income Tax Act. In case of short-term capital gain on such shares, the gains were taxed at 15 per cent.
Hence, even while buybacks had been an effective option for companies, as they were not taxed on the repurchase of their shares, the investor had to understand the tax liability and choose options accordingly.
Since the start of 2015, 95 per cent of buybacks had been through the tender offer, compared to between 2006 and 2014 when nearly 80 per cent of the buybacks were through the open market. The regulator had also increased the disclosure requirements for the buybacks and had lowered the duration from 1 year to 3 months (Burugula, 2017).
Another aspect to consider in buybacks was the acceptance ratio which represented the number of shares that would be accepted for the buyback as a percentage of the offered shares per investor. SEBI has mandated a reservation of 15 per cent of the buyback offer for retail investors holding up to ₹200,000 (USD29,641) (market value as on record date). With the corpus of ₹160 billion (USD2.37 billion) for the buyback offer, TCS was proposing to buy back 56.1 million shares at ₹2,850 per share on a proportionate basis. This was around 10 per cent of the 525.5 million TCS shares held by the public (Aggarwal, 2017). This implied that only about 1 in every 10 shares could be accepted. Since, not all shareholders tendered and whoever did may not part with their entire holdings, acceptance remained a bit of a wild card factor for the retail investors.
Another important factor to take into account was whether promoters were participating in the buyback. Promoters were not allowed to participate in the open market method, but the tender offer method was open to them. According to Jimeet Modi, CEO, SAMCO Securities, ‘If there was promoter participation, the buyback was likely to be positive for the stock in the long run’. For example, if Tata Sons participated in the buyback process of TCS, as 73.31 per cent of shareholders, they would be the biggest beneficiaries. As the promoter group they would get a handsome sum of ₹117.3 billion of nearly ₹160 billion (USD2.37 billion) (Dubey, n.d.).
Research studies demonstrated buybacks as an ineffective tool for value creation in the long run as they could not sustain the short-term prices changes. Since the stock price changes happened due to only apparent and financially engineered jump in the EPS, they did not sustain in the long run (Lazonick, 2014). The top 10 buybacks in India showed that shares gained an average of 1.5 per cent 1 year after the repurchases ended. Returns had been slightly better at 8 per cent and 6 per cent 1 year after the buybacks announcement and commencement. In the case of the top 20 buybacks by size, average returns 1 year after their announcement, commencement and end were 7.4 per cent, 8.5 per cent and 4.3 per cent, respectively (Comment, 2017).
Buyback Dilemma
Although successful repurchases required transparent disclosures, clear strategy and motive behind buybacks as an integral part of the disclosure scheme, companies rarely complied, leading to a failure of investors to judge the process and success of buybacks relative to established goals. Other key debatable shortcomings related to the timing of the buyback and the moral hazard of executive compensation being positively correlated to a financially engineered EPS jump, especially in markets like the USA.
US markets started the buyback of share process earlier than the Indian markets. Critics of buybacks in the US markets had pointed out that companies and managers who used buybacks to boost stock prices before their senior management, who had been given generous stock options, started cashing in on their stock options. Critics also point out that in many of the leading US companies, distributions to shareholders were well in excess of net income and that the distribution of cash as buybacks came at the cost of innovation and employment. Williman Lazonick (2014) in his case ‘Profits Without Prosperity’, mentions that between 2003 and 2012, the 10 largest repurchases in the USA (refer to Table 7) spent a combined US$859 billion on buybacks, an amount equal to 68 per cent of their combined net income. He said that ‘by permitting the massive distribution of corporate cash to shareholders, the buyback exercise undermined capital formation, including human capital formation in the US economy’ (Lazonick 2014, p. 28).
The Top 10 Share Buybacks in US 2003–2012
Buyback strategy ideally depended on the requirements and strategy of each individual company; however, businesses seemed to follow the trends of the industry and competitors. For example, Cognizant, that had come out with a buyback programme, had not distributed dividends and it seemed it wanted to use buybacks as an active strategy to return cash to its shareholders. Infosys, TCS or any other Indian IT company should consider its own overall company strategy and value creation philosophy to guide them before they joined in the trend.
Declaration of Conflicting Interests
The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this case.
Funding
The authors received no financial support for the research, authorship and/or publication of this case.