Buy back of shares?! What are the other options?

We all have heard about buy back of shares i.e. company buying back the shares that it has issued in the market and reducing the supply of the same in the market. It can be done by companies for many purposes like to increase the price of shares by reducing the supply so as to meet the requirements of the index in which it is listed, to give away the excess cash to its shareholders etc.

How right is it to buy back shares? Does it indicate anything that should be probed further regarding the growth of the company? Is giving cash back to shareholders only option to retire that cash?

We all are aware of huge cash piles of many IT companies. Companies return this cash to shareholders when they don’t have investment options, in the form of huge buyback program or dividends etc. with a view of maximizing shareholder value or value creation or wealth maximization whatever we call it. We all know about the Apple’s buyback program as well. Apple has raised only $97 million in the form of IPO from the public till now in 1980 and post that it was all the company’s magic which has created so much wealth to the company! Innovation seems to be the only word which can describe Apple and the value of it. The I-phone maker spent $18 billion on its own shares from January to March in buy back and rallied close to 32% after a $16 billion buyback in 2013.

Does this buyback program indicate stagnation of business in any way because it is not having options to invest? Does this return really create shareholder wealth? Don't know. Need to probe further!

I was reading a blog of HBR, where the author brings up an interesting point as to whether creating shareholder’s wealth is really significant? Do those investors really invest for the purpose of creating value? Author seems to slightly dislike the concept of maximization of shareholder value because the investors don’t directly invest in any value creating capabilities of the company. They buy shares of the company in the market with a feeling that stocks might go up and that creates wealth for them with market price appreciation.

As against those investors if we think of workers or government, they actually are part of value creation for a company because the workers with skill sets contribute to success of the company and government by providing infrastructure and various other facilities is also a part of value creation in the company. So the companies instead of returning the cash to shareholders can make use of the cash in creating some value for these holders instead of investors who trade in the shares that are floated in the market.

The author very nicely suggests few measures which the company can take up to make use of the excess pile of cash. Some of them are, educating employees of the organization by sponsoring courses which employees themselves cannot afford to have. A tuition assistance program for the employees would be very good measure to make use of this cash. Companies can also do social investment which can be in any field which the country is lacking, may be education, infrastructure, poverty etc. It makes the corporate a social citizen as well. It can also invest in social innovation by encouraging youth or smart brains of the country to come up with ideas that would make a difference in the society. These kind of actions would be more appreciated by the investor community than buying back shares and causing market value appreciation. 

QE, Fed rates and Fed tapering (Why, what, how & what if)

Any country basically has 2 policies one being the monetary policy which regulates the money supply in the country and the other one being fiscal policy which regulates the money the government earns and spends. A country to be seen as attractive for the purpose of investment, fundamentals of the economy should be strong and have capacity to generate good returns for the risk taken. Broadly key factors that will be looked for when investing in a country will be interest rates, inflation & growth prospective which is influenced by factors like industrial production, currency stability, unemployment situation in the economy, inflation etc.. I am trying here to analyze more about the monetary policy, its effectiveness in taming inflation and spurring growth with reference to Fed rates, QE program and Fed tapering.

After the 2008 financial crisis, US started the process of Quantitative Easing (QE) to combat the subprime crisis that it went through. US economy had halted and there was no growth and unemployment level was increasing. To spur the growth, production has to increase which would directly reduce the unemployment. For production to rise, more money was needed and even though the fed rates were close to 0% it failed to give the required stimulus and therefore this QE (Bond buying program), which is the last resort to revive the economy on failure of monetary policy, was initiated. It infuses money to the economy lowering the interest rates as well as the exchange rate of dollar which would make US investments attractive which would further lead to inflow of more capital. Its bond buying program of $85billion a month was reduced to $75 billion in June 2013 but again on the backdrop of lagging growth it revived its program within 2 months and then decided to phase out the program by end 2014. After that the size of repurchase has been reducing and it’s currently $25 billion a month. This phase out of reducing the size of bond buying is termed Fed tapering.

Fed clarified it would stop this QE program once the targets are met i.e. unemployment below 6.5%, inflation in the range 2.5% to 3% and GDP growth rate of 2% to 3%. And now the numbers are close to target, and tapering would stop by next month. As a result interest rates are likely to go up as the artificial demand infused by QE is taken out from the market. And if the rates increase bond markets will be hugely impacted as it means lower price of the bonds at least on paper. As soon as the rates in US rises, capital starts moving out of emerging countries's bond markets and flows into US debt market. And as an effect the currency of that country depreciates against dollar and if it is an import driven country like India then it will start building current account deficit. So this way actions of US creates chain reaction in other emerging economies. But as per recent statement by our RBI governor Raguram Rajan, India is better prepared to face the fed rate increase as the chances of capital outflow are less due to better growth prospects here in India and another line of defense for India being the plenty of forex reserves which it has built over the past year which is close to $327 billion.

There has been mixed opinion regarding rate hikes with one group telling numbers are short term and if rates are raised US may again fall out growth track and another opposite view supporting rate hikes. Nobody is sure when Fed will start raising the rates and everyone is speculating. But what we can be glad about is the growth path that India is treading in the Modi’s reins and the preparedness or cushion India has developed to face the Uncle Sam’s sneeze if any!

QIPs, What I know of it!

Past few months we have seen many companies like reliance communications, Idea, GMR infrastructure & JP associates raising funds through QIPs and now Adani enterprises is on the same line. So what do we understand by QIP? Why are they used by companies? We will also try to understand the pros and cons of it with few market examples of QIPs which have succeeded or failed in the past.

QIP stands for Qualified Institutional Placement. Before introduction of QIPs companies were making use of ADRs and GDRs to rise funds from international source and this bothered the economy and that’s why SEBI introduced QIP norms in 2006 with regulations and flexibility which would help mobilization of domestic capital. A company can issue equity shares, fully and partly convertible debentures, or any securities other than warrants which are convertible to equity shares to a Qualified Institutional Buyer (QIB). Apart from preferential allotment, this is the only other speedy method of private placement whereby a listed company can issue shares or convertible securities to a select group of persons.

QIPs are used by companies because of mainly 2 advantages i.e. speed with which they can raise funds due to less regulations and document work which is to be done if it is an IPO and second factor being cost. If it is an IPO or rights issue, or FPO, the cost of rising funds is more because of appointment of lawyers, auditors, lead bankers, underwriters etc. whereas here such procedures are not needed. They are priced based on the average 2 weeks high & low price of the security. And this issue can only be made to QIBs i.e. Qualified Institutional Buyers are institutional investors who don’t need protection from SEBI in performing due diligence activity that will be undertaken by SEBI in the form of documents that it asks the companies to submit before offering an IPO. They are capable of conducting their own due diligence before investing such a hefty amount of money and they take their position cautiously after all calculations.

Main advantage for QIBs in this investment is if they are convinced with the fundamentals of the company, they can get large chunk of share in in the company and it is advantageous buying through QIP route than market route because large buy in market would distort the price at which it is being traded due to volatility. And sellers can sell or exit their position any time they feel like unlike lock in period in certain type of investment. Coming to fears about QIP, companies that raise funds through QIP should be cautious as there is no lock in period for the buyers to stay in and it also leads to dilution of ownership rights as QIPs enable QIBs get majority stake in companies.

There have been few very successful investments via QIP routes which have increased enormously in value like Godreg Consumeer Products which has increased by 161% from 345 per share to 903 per share now and Apollo Hospitals which has increased by 134% from a share price of 495 to 1159. There have also been few disastrous choice made by QIBs which have crumbled in their share prices like 3i Infotech whose share price has fallen by 88% from 78.6/- per share to 8.86/- per share now and Dhanalaxmi Bank whose value has fallen by 74% from 181.3 to 46.8 per share.

Again coming to the ground reality this is just a game of money where one person uses QIP as source of fund and another person invests or lends on the basis of his strategic analysis of the company where he invests. Success depends on various factors one of them being the borrower himself because success factor depends on how well he strategises his investment to create value.

New Development Bank:

The New Development Bank (NDB), formerly referred to as the BRICS Development Bank, which came into existence in the 6th BRICS meet in Brazil, is multilateral development bank operated by the BRICS states (Brazil, Russia, India, China and South Africa) as an alternative to the existing World Bank and International Monetary Fund. The Bank is setup to foster greater financial and development cooperation among the five emerging markets. It would be headquartered in Shanghai, China and the first chief executive will come from India.

Purpose: The NDB has been given $50 billion in initial capital. As with similar initiatives in other regions the BRICS bank appears to work on an equal-share voting basis, with each of the five signatories contributing $10 billion. The capital base is to be used to finance infrastructure and “sustainable development” projects in the BRICS countries initially, but other low- and middle-income countries will be able buy in and apply for funding. BRICS countries have also created a $100 billion Contingency Reserve Arrangement (CRA), meant to provide additional liquidity protection to member countries during balance of payments problems. The CRA—unlike the pool of contributed capital to the BRICS bank, which is equally shared—is being funded 41 percent by China, 18 percent from Brazil, India, and Russia, and 5 percent from South Africa.

Reason for establishing NDB?

The BRICS (Brazil, Russia, India, China and South Africa) are gaining in economic power and crave the political clout to match, but standing in the way is a global financial system organized by the West and dominated by the U.S. They’re forced to conduct their international business in the unstable U.S. dollar, making their economies swing back and forth with the winds of policy crafted in Washington, D.C., and New York City.

As of 2010, despite having the world’s second-largest economy, China is still locked out of the IMF’s top five shareholders, with only 3.81 percent of total voting power, while Brazil, with an economy comparable to France and the UK, is only permitted to wield 1.72 percent of votes at the institution. Although the BRICS comprise over one-fifth of the global economy, together they wield about 11 percent of the votes at the IMF. The top five IMF shareholding nations have literally refused to make room at the table for these other powerful states, which could, with a little compromise, quite easily have become their natural allies. For a very long time, the US and other Western States, which together control most aspects of IMF and World Bank lending, abused their position at those institutions in the service of their own national interests.

Reasons why this bank matters?

• First, it demonstrates the viability and dynamics of the BRICS despite all the skepticism and criticism in recent years
• Second, the BRICS bank demonstrates China’s global leadership. 
• Third, the BRICS bank is significant because it is a direct challenge to the global order led by the West. 

The new BRICS development bank is unlikely to replace the IMF and World Bank in the near future as the latter will still remain powerful players in the global economic order. The most likely relationship between the two is a complementary relationship rather than a conflicting one. That said, in the long run the competition between the two will intensify and the final outcome will depend on the balance of power between the two blocs: the developing world and the developed world. What is for sure is that we are in for some interesting times!!

REITs

What is REIT?

REITs or Real Estate Investment Trusts are a special type of investment vehicle which operate more like mutual funds but invest in real estate properties for returns. These properties are usually income generating properties, commercial or residential, and the returns from such investments are passed on to the investors in the REITs. Usually REITs' units, issued by fund houses, are traded on the bourses and investors can buy and sell those units like stocks. In India, market regulator is in the process of formulating rules for launching REITs in India. Real estate is a big ticket investment with a huge chuck of money getting locked in buying a property. The advantage of REIT is availability of exposure to real estate with a smaller ticket size as well as diversification of investment by REIT. The various types of REITs include equity, mortgage and hybrid ones.

To ensure that only established players launch REITs, the minimum size of assets under management has been proposed as Rs 1,000 crore. Initially, the minimum investment size will be Rs 2 lakh, which may keep retail investors away from this new market. Units of a REIT are compulsorily required to be listed on a recognized stock exchange. At least 90% value of REIT assets should be in ready properties generating revenue. The remaining 10% can be in other specified assets. REITs will have to distribute at least 90% of their net distributable income after tax to investors.

Parties involved:

The parties in the REIT include the sponsor, the manager, the trustee, the principal valuer and the investors / unit holders. Sponsor sets up the REIT, which is managed by the manager. The trustee holds the property in its name on behalf of the investors. The roles, responsibilities, minimum eligibility criteria and qualification requirements for each of the abovementioned parties are detailed in the Draft Regulations. Sponsors are required to hold a minimum of 15% (25% for the first 3 years) of the total outstanding units of the REIT at all times to demonstrate skin-in-the-game.

Use of SPV: REITs may hold assets directly or through an SPV. All entities in which REITs control majority interest qualify as an SPV for the purpose of the Draft Regulations.

Benefits:

• REITs provide the sponsor (usually a developer or a private equity fund) an exit opportunity thus giving liquidity and enable them to invest in other projects
• It provides the investors with an avenue to invest in rental income generating properties in which they would have otherwise not been able to invest, and which is less risky compared to under-construction properties.
• IT brings in increased transparency in the sector by adopting better corporate governance, disclosures and financial transparency practices
• It will also provide a vehicle for addressing non-performing assets (NPAs) including sick or defunct companies holding large land banks. Sale of such NPAs to REITs will have a twofold effect—realization of the real estate’s true value and ease in liquidating the NPA once the high value of the real estate is removed from its books.