Share Buybacks. Impact on Tadawul (Saudi Stock Exchange) AlJazira Research

Transcription

1 Impact on Tadawul (Saudi Stock Exchange) AlJazira Research

2 Table of Contents Section Contents Page 1 An introduction to the history and Saudi regulation on buyback shares 2 2 The rules of Share Buy-back in Saudi Arabia 3 3 Share Repurchase methods 5 4 The impact on the company s Financial statements after shares repurchases 6 5 Share Repurchases vs. Dividends 7 4 The Positive Side of Share Buybacks 8 5 The Negative Side of Share Buybacks 9 6 Stock Repurchases Timing and motive 10 7 Listed Saudi companies met with the CMA rules of shares buy-back 11 9 Case in Stock Repurchases Johnson & Johnson Appendix Appendix A Chapter One: Share Buy-back Rules Appendix B Chapter Two: Effect of a Buy-back Transaction Appendix C Chapter Three: Rules of Company s Sale and Pledge of Shares Appendix D Chapter Four: Employees Shares 14 1

3 An introduction to the history and Saudi regulation on buyback shares History of Share Buyback Most buyback programs worldwide follow the open-market (stock market) method, wherein the company announces a buyback program and repurchases shares in the open market. Share buyback became increasingly popular after US loosened its rules in 1982, while Japan and Germany in 1984 and 1986, respectively. Large share repurchases in Europe started later than those in the US, but are currently common practice in the global financial markets. Share Buyback Share repurchase or buyback refers to a publicly traded company buying its own shares from existing shareholders. Repurchased shares become part of treasury shares in equity(can be reissued in future) If treasury shares are retired, those shares cannot be reissued in future. Like dividends, share repurchase is an instrument used by companies to return excess cash to shareholders. Shareholders have an opportunity to get cash in lieu of their shares, leaving the remaining shareholders with a larger claim on the company s net equity and future earnings. Share Buyback in Saudi Arabia Rules governing share buyback in Saudi Arabia are issued by the board of the Capital Market Authority (dated 17/10/2016 ) based on regulations and procedures related to listed joint-stock companies under Part Four of the Companies Law. The latest amendment by the Resolution of the board of the Capital Market Authority was on 23/3/2017. However, updates in strategic rules and regulations are not indicated in Tadawul s periodic reports or announced by the company. This new law can benefit companies such as, Saudi Basic Industries Corp., Saudi Telecom Co., Saudi Airlines Catering Co., Al Tayyar Travel Group Holding Co., Jarir Marketing Co., Saudi Arabia Fertilizers Co., etc which are better positioned for share buyback as per CMA rules. (company list on slide 12) 2

4 The rules of Share Buy-back in Saudi Arabia According to the chapter one (Article 12-17) under the rules of Share Buy-back in Saudi Arabia; a listed company may be permitted by law to buy back its ordinary or preferred shares in accordance with the following rules: 1. The purpose of the share buy-back shall be to either reduce the Company s capital or to retain them as Treasury Shares; 2. the Treasury Shares of the Company, must not at any time exceed 5% of the total shares in the class of Shares subject of the buy-back; 3. the Company, based on a report issued by the Company s auditor, must satisfy the following solvency requirements: Prior to buying, the Company must have sufficient working capital for the (12) months immediately following the date of completion of the share buy-back transaction. the value of the Company s assets must not be less than the value of its liabilities (including contingent liabilities), prior to and immediately upon payment of the purchase price. The amount of Treasury Shares held must not exceed the amount of the retained profits of the Company. 3

5 The rules of Share Buy-back in Saudi Arabia 1. The extraordinary General Assembly approval of the Share buy-back transaction and determining its purposes, the maximum number of Shares subject to the buy-back, and the buy-back funding method. 2. The buy-back transaction must not cause the ownership of the public in Shares of the same class to decrease to less than 30% or any other percentage specified in the prospectus approved by the Authority. 3. Unless the purpose of Share buy-back transaction is reducing the share capital of the company, the Share buy-back transactions must be executed through the Exchange must not be through a private transaction. 4. The Company must not have a sale order in place while buying Shares. 5. The amount the Company will pay to buy-back its shares must not exceed the amount of distributable profits, whether the buy-back will be made through its own cash accounts or external sources of financing. 6. A Company may not buy-back its shares to use them as Treasury Shares except for the following purposes: If the Board or its authorized representative, considers that the Share price on the Exchange is lower than its fair value. To fulfill convertible debt instruments holders right to convert them into Shares in accordance with the terms and conditions of those instruments. Share swap transactions for the acquisition of shares or limited liability company s interests or an asset purchase. To allocate them to Company s employee as part of an Employees Shares plan. Any other purpose approved by the Authority. 4

6 Share Repurchase methods Open Market Fixed Price Tender Offer Dutch Auction Tender Offer Direct Negotiation Company buys its shares from open market Cost-effective if properly timed to reduce share price impact Tender offer by company to buy specific number of shares at certain price, which is generally at premium to CMP In case more shares tendered than specified, company chooses to buy shares on pro rata basis Instead of specifying fixed price (such as in fixed price tender offer), company specifies range of prices at which shareholders can give their shares for buyback Method allows company to identify minimum price at which it can repurchase shares Company directly negotiates with a major shareholder for share buyback Helps keep large block of shares coming to market and depressing stock price Method can also be used to repurchase shares from potential acquirer 5

7 The impact on the company s Financial statements after shares repurchases Income statement: A share repurchase does not affect a company s total revenue and profits. However, the lower number of outstanding shares due to the buyback increases per-share earnings (EPS) and per-share dividends (DPS), among others. Example: Share buyback of 100 Shares (@SAR 1each) In SAR Before After Net income 10,000 10,000 Share outstanding 1, Dividend 2,000 2,000 EPS DPS Balance sheet: Repurchased shares become part of treasury shares in the equity portion of the balance sheet. Treasury shares act as contra-equity, which effectively reduces the company s total equity. On the asset side, the company s cash balance is reduced by the total amount spent on the share buyback. In SAR Before After Cash Operating assets Total assets Equity Treasury shares Cash Flow statement: In the cash flow statement, the amount spent on a share repurchase program is recorded as an outflow from cash flow from financing activities. 6

8 Share Repurchases vs. Dividends Share Repurchases vs. Dividends (Basic Example) Dividends Impact Shares Outstanding=1,000 Share Repurchases Impact Shares Outstanding=1,000 Share price=sar 10 Share price=sar 10 Market Value = 10,000 Market Value = 10,000 DPS= SAR 1 Share Repurchase = 100 share (each at SAR 10) Total Dividend= SAR 1,000 Share Repurchase = SAR 1,000 Value of Firm = Market value Total Dividend = 10,000-1,000 = SAR 9,000 Value of firm = Market value Share Repurchases = 10,000 1,000 = 9,000 Outstanding Share (After Dividend) = 1,000 Outstanding Share (After Repurchases)= 900 Investor Receive (holding 10 shares)-before tax = SAR 10 Investor Receive (holding 9 shares after 10% repurchase)-before tax = SAR 10 Investor Receive (holding 10 shares)-after 5% withholding tax for non-resident = SAR 9.5 Investor Receive (holding 9 shares after 10% repurchase)-after tax (no capital gains for share listed on tadawul) = SAR 10 Hence, we can conclude that before-tax gains from dividends and capital gains are same. For non-resident investors, however, after-tax gains from repurchases are higher than those from dividends as there is no tax on capital gains for stocks listed on the Tadawul, but there is a 5% withholding tax on dividends for non-resident investors. 7

9 8 The Positive Side of SHARE Buybacks Effects on Share Price and Investor Sentiment Share buybacks Impacts are generally of Share taken Repurchases a positive signal by investors. It reflects the company/management confidence in its own business, which generally acts as a positive catalyst for the company s share price. Buybacks eliminate threats by shareholders looking for a controlling stake. The tax treatment for buybacks is more favorable (no capital gain tax for shares listed on Tadawul) for non-resident investors in KSA than that for dividends (5% withholding tax for non-resident inventors). The program helps the company distribute extra cash to investors while maintaining dividends at the same level. Unlike dividends, share repurchases are not a long-term commitment. Share buybacks with debt (or without debt in some cases) can help a company quickly move to its targeted capital structure. Effect on Financials and Ratios The company s EPS increases after a share buyback as fewer outstanding shares remain. For example: ABC company plans to buy back 100 shares with its excess capital. The company s current stock price is SAR 10 and there are 1,000 shares outstanding prior to the repurchase. ABC s net income is SAR 5,000, translating into EPS of SAR 5. Performance matrices and valuation after buybacks (PE/ROE/ROA) EPS after buyback = SAR 5,000/( ) = SAR 5.6 The PE ratio decreases as EPS increases (assuming constant stock price, but stock price generally rises after share buybacks) ROE increases, as the company s book value decreases (generally, when book value is higher than stock value) ROA increases as the company s assets (cash) decrease. Other Effects Share repurchases prevent companies from hoarding cash. Buybacks offset the dilution from employee stock options.

10 The Negative Side of Share Buybacks Effects on Share Price and Investor Sentiment A company can use buybacks to provide false signals to the market by artificially boosting EPS and causing a short-term rise in the stock price. Insiders may use the quick movement in prices to sell off some of their holdings in the company. The company may misjudge the market and buyback shares when they are overpriced, thus eroding investor value. A company must hold shares purchased in buybacks for a certain period before reselling. In this period, the company may lose an opportunity to sell shares at a higher price if the stock price rises. The company s total fundamental value remains unchanged. Effect on Financials and Ratios The company becomes more leveraged by increasing net debt levels (by using existing cash or borrowing for buybacks). Liquidity decreases, inhibiting future expansion or capex. A company buying its own shares may reflect limited opportunities for it to profitably invest elsewhere, implying limited prospects and growth opportunities. Other Effects The company has to bear bureaucratic and processing costs (approvals, documentation, etc.) of share repurchases. 9

11 Stock Repurchases Timing and motive Timing During depressed stock prices (due to extraneous reasons) Undervaluation of stock by market due to excessive panic on some news story Expectation of better future performance by the company GE repurchased shares worth USD 12.3bn in 2007, just before the market crashed; it sold shares worth USD 600mn in 2009, when the market was starting to get bullish. Overall, GE repurchased around USD 44bn (17% of its market cap) in the past decade. Over the same period, its stock fell 15%. By inefficiently using capital to buy back shares at inflated prices, the company lost value for its long-term shareholders. Motive Attract investors by showing company s confidence in own business Discourage hostile bidders by increasing leverage or repurchasing directly from them 10

12 Listed Saudi companies met with the CMA rules of shares buy-back Potential Companies for SHARE BUYBACK (excluding Banks) CMA mentioned criteria are mostly subjective and most of them can be fulfilled by companies while making buyback offers(for e.g. The amount of Treasury Shares held must not exceed the amount of the retained profits). To short list above companies we have used CMA criterion (prior to buying the Company must have sufficient working capital for the (12) months Impacts immediately of Share following Repurchases the date of completion of the share buy-back transaction) and other important metrics (apart from CMA criterion) that we feel are important for a robust balance sheet. We have excluded banks from the list since current ratio/ working capital are not comparable with rest of sectors, however, all banks can potentially buy back shares. We should also note that companies not included in the list are expected to buy back shares for Employee incentive programs. Following numbers are assumed for stock screening. Note that CMA does not mention specific numbers instead it uses words like sufficient etc. 1. Companies with current ratio greater than 1 ( indicates sufficient liquidity) 2. Companies with Debt to Equity lower than 0.5 ( low leverage) 3. Companies with Working Capital to Sales less than 25% ( indicates sufficient sales to cover working capital requirements) 4. Companies with stable and continuous dividends payments (excess cash can be used for buyback) Company name(adjusted Market Cap (SAR Mn) Cash(SAR Mn) Working Capital /Sales (Adjusted for cash) Debt to Equity Current Ratio Current Current Saudi Basic Industries Corp.* 304,208 49, % Saudi Telecom Co.* 138,004 3,068 15% Saudi Arabia Fertilizers Co. 25, % Jarir Marketing Co. 12, % Saudi Ground Services Co. 7, % Saudi Airlines Catering Co. 6, % Dallah Healthcare Holding Co. 6, % Al Tayyar Travel Group Holding Co. 5, % Saudia Dairy and Foodstuff Co. 4, % Herfy Food Services Co. 3, % Taiba Holding Co. 5, % Saudi Company for Hardware 2, % Aseer Trading, Tourism & Manu Co. 1, % *Please note that the company s free float shares are less than 30%

13 Case in Stock RepurchasesJohnson & Johnson Case Study : Johnson & Johnson Johnson & Johnson has a strong history of delivering increased value for shareholders in the form of stock buybacks. Since 2012, the company has thrice announced share buybacks program; 1) USD 12.9bn on June 12, ) USD 5.0bn on July 21, ) USD 10bn October 13, A positive trend is seen after each stage of share repurchase announcements. Share repurchase has helped improve per share financial metrics and increase worth of remaining shareholder s. 240 July 21, 2014 October 13, Announcement date: June 12, Jan-11 Aug-11 Mar-12 Oct-12 Jun-13 Jan-14 Aug-14 Mar-15 Oct-15 Jun-16 Jan-17 Aug-17 Johnson & Johnson (Rebased) S&P500 (Rebased) 12

14 Case in Stock Repurchases Johnson & Johnson The below figure indicates that DPS and EPS are higher after each repurchase. Share repurchases made with excess cash have the potential to increase earnings per share, whereas those made with borrowed funds can increase, decrease, or not affect earnings per share, depending on the after-tax borrowing rate. Figures in USDmn (except per share) Net Income 10,514 13,831 16,323 15,409 16,540 Dividend paid 6,614 7,286 7,768 8,173 8,621 Common stock repurchased 12,919 3,538 7,124 5,290 8,979 No: of Shares Before Repurchases 3,017 2,933 2,977 2,897 2,931 No: of Shares After Repurchases 2,812 2,877 2,864 2,813 2,789 Total Payout to Net Income % 186% 78% 91% 87% 106% EPS (before repurchase) EPS (after repurchase) DPS (before repurchase) DPS (after repurchase)

15 Appendix Appendix A (Chapter One): Share Buy-back Rules Article twelve: A Company may, if so provided and permitted in its bylaws, buy-back its ordinary or preferred shares, in accordance with the following rules: 1. the purpose of the share buy-back shall be to either reduce the Company s capital or to retain them as Treasury Shares; 2. the Treasury Shares of the Company, must not at any time exceed 5% of the total Shares in the class of Shares subject of the buy-back; 3. the Company, based on a report issued by the Company s auditor, must satisfy the following solvency requirements: prior to buying its Shares the Company must have, on its own or with its subsidiaries, sufficient working capital for the twelve (12) months immediately following the date of completion of the share buy-back transaction. the value of the Company s assets must not be less than the value of its liabilities (including contingent liabilities), prior to and immediately upon payment of the purchase price, according to the latest reviewed interim financial statements or audited annual financial statements, whichever is later. The amount of Treasury Shares held must not exceed the amount of the retained profits of the Company. 4. the extraordinary General Assembly approval of the Share buy-back transaction and determining its purposes, the maximum number of Shares subject to the buy-back, and the buy-back funding method. The extraordinary General Assembly must also authorise the Board to finalise the buy-back transaction, in one or several phases, within a maximum period of twelve (12) months from the date of the above mentioned extraordinary General Assembly s resolution. The Company must announce the approval of the buy-back transaction and its conditions, immediately after the relevant resolution of the extraordinary General Assembly is issued. The extraordinary General Assembly may at any time issue a resolution to change the purposes of the Shares buy-backs; 5. Unless the purpose of Share buy-back transaction is reducing the share capital of the company, the buy-back must not exceed 10% of the total quantity approved for buyback by the General Assembly in one trading day, unless the total approved quantity, or the remaining of the approved quantity that has not been bought-back, is lower than 10% of the trading volume on the day preceding the buy-back transaction; 14

16 Appendix 6. the purchase price shall not exceed 5% of the closing price on the day preceding the day the Share buy-back transaction is executed; 7. The buy-back transaction must not cause the ownership of the public in Shares of the same class to decrease to less than 30% or any other percentage specified in the prospectus approved Impacts by of the Share Authority Repurchases 8. Unless the purpose of Share buy-back transaction is reducing the share capital of the company, the Share buy-back transactions must be executed through the Exchange must not be through a private transaction ; 9. the Company must not buy-back its Shares during the following periods: during the fifteen (15) calendar days preceding the end of the financial quarter and until the date of the Company s announcement of its reviewed interim financial statements; and during the thirty (30) calendar days preceding the end of the financial year and until the date of the Company s announcement of its reviewed interim financial statements or its audited annual financial statements; 10. the Company must not have a sale order in place while buying Shares. 15

17 Appendix Article thirteen: A Company may not buy-back its shares to use them as Treasury Shares except for the following purposes: a. If the Board or its authorized representative, considers that the Share price on the Exchange is lower than its fair value. b. To fulfil convertible debt instruments holders right to convert them into Shares in accordance with the terms and conditions of those instruments. c. Share swap transactions for the acquisition of shares or limited liability company s interests or an asset purchase. d. To allocate them to Company s employee as part of an Employees Shares plan. e. Any other purpose approved by the Authority. Article fourteen: A Company must, upon completion of each phase, announce to the public the results of the Share buy-back transaction at least half an hour prior to the start of the trading session on the day following the completion of each phase of the buy-back transaction. Article fifteen: The Board annual report must contain details relating to Treasury Shares retained by the company and details on the use of these shares. Article sixteen: The amount the Company will pay to buy-back its shares must not exceed the amount of distributable profits, whether the buy-back will be made through its own cash accounts or external sources of financing. Article seventeen: If the purpose of a Company s buy-back of its Shares is to decrease its share capital, the provisions of Article 148 of the Companies Law must be taken into consideration. 16

18 Appendix Appendix B (Chapter Two): Effect of a Buy-back Transaction Article eighteen: a. If a Company buys-back its Preferred Shares, they are deemed cancelled upon completion of the buy-back transaction and the Company must then take necessary regulatory procedures as a result of purchasing these Preferred Shares. b. The Company planning to purchase a class of its Preferred Shares must make an offer to all the holders of that class of Preferred Shares in a manner that provide equality among that class of Preferred Shares holders according to the provisions of Article 148 of the Companies Law. Article nineteen: The extraordinary General Assembly shall determine, within its resolution approving the Share buy-back transaction, the maximum time period during which the Company may retain its Treasury Shares without selling them or allocating them to its employees as Employees Shares Plan, and the Company must not dispose of these Shares after the elapse of the mentioned period, and must take necessary regulatory procedures to cancel these Shares within a period not exceeding six months after the end of that period, unless the extraordinary General Assembly resolved to extend the period for which the company may retain the Treasury Shares before the said six month elapses. Article twenty: Unless the Treasury Shares are allocated to the Company s employees as part of the Employees Shares Plan, a Company may not increase its share capital through a rights issue if it retains Treasury Shares or if the extraordinary General Assembly approved a Share buy-back transaction, and did not cancel such approval. Article twenty one: If a Company which retains Treasury Shares increases its share capital through a capitalisation issue, it shall have rights similar to those of other shareholders with respect to such Shares. 17

19 Appendix Appendix C (Chapter Three): Rules of Company s Sale and Pledge of Shares Accordance with the following rules: 1. The approval of the Board on the sale of Treasury Shares, without prejudice to the extraordinary General Assembly s resolution on the approval of buying these shares. 2. The sale of Treasury Shares transaction must not exceed 10% of the total Treasury Shares to be sold, during one trading day, unless the total quantity of Treasury Shares to be sold is lower than 10% of the trading volume of the Company s Shares on the day preceding the buy-back transaction; 3. Announce to the public the results of sale of Treasury Shares transaction, upon completion of each phase, at least half an hour prior to the start of the trading session on the day following the completion of each phase of sale of Treasury Shares transaction. 4. The sale transactions must be executed through the Exchange must not be through a private transaction. As an exception, the sale of these Shares is not required to be executed through the Exchange if the purpose of the Treasury Shares is to fund share swap transactions for acquiring a company or an asset or to fulfil convertible debt instruments holders right to convert them into Shares in accordance with the terms and conditions of those instruments; 5. The company must not sell its Treasury Shares during the following periods: during the fifteen (15) calendar days preceding the end of the financial quarter and until the date of the Company s announcement of its reviewed interim financial statements; and during the thirty (30) calendar days preceding the end of the financial year and until the date of the Company s announcement of its reviewed interim financial statements or its audited annual financial statements; and 6. The Company must not have a buy order in place while selling Shares. Article twenty three: A Company may pledge its Shares as security for a debt, if so provided and permitted in its bylaws, in accordance with the following rules: 1. The pledge must benefit the Company and its shareholders, this shall be based on a statement issued by the Board; 2. The ordinary General Assembly must approve the Share pledge transaction, and a pre-approval may be granted for several transactions; and 3. The pledge must not result in a breach of the Companies Law and any other relevant rules and regulations. 18

20 Appendix Appendix D (Chapter Four): Employees Shares Article twenty four: If a Company is buying-back its Shares for the purpose of allocating them to its employees within an Employees Shares plan, the Company must, in addition to the other requirements of a share buy-back, comply with the following rules: 1. The Company s bylaws must provide and permit that; 2. Obtain the extraordinary General Assembly s approval on the Employees Shares plan. The General Assembly may authorize the Board to determine the terms of the plan including the allocation price for each Share offered to employees if offered for consideration; and 3. Non-executive Board members shall not participate in the Employees Shares plan, and executive Board members shall not vote on Board resolutions relating to the plan. 19

21 RESEARCH DIVISION Head of Research Talha Nazar Analyst Sultan Al Kadi, CAIA Analyst Jassim Al-Jubran Analyst Waleed Al-Jubayr Analyst Muhanad Al-Odan BROKERAGE AND INVESTMENT CENTERS DIVISION General Manager Brokerage Services & sales Alaa Al-Yousef AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa AGM- Head of Western and Southern Region Investment Centers Mansour Hamad Al-Shuaibi AGM-Head of Sales And Investment Centers Central Region Sultan Ibrahim AL-Mutawa AGM-Head of Qassim & Eastern Province Abdullah Al-Rahit RESEARCH DIVISION RATING TERMINOLOGY AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. 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