Analyst Corner: Maintain ‘reduce’ on TCS as stock valuations are punchy

Buyback—a surprise. The TCS board will consider buyback of equity shares on October 7, 2020. Tax arbitrage exists between dividend and buyback depending on the recipient. Buyback through the tender route is essentially an alternative form of dividend distribution; hence the discussion on EPS dilution due to buyback is not relevant. The maximum quantum of buyback through board and shareholder approval route is Rs 89/220 billion. The buyback has taken a few by surprise given expectations of supply of TCS stock from the principal shareholder to fund buyout of Shapoorji Pallonji (SP) Group’s stake in Tata Sons. Stock valuations are punchy; maintain ‘reduce’.

The TCS board will meet on October 7 to consider a buyback of shares. TCS had net cash of `511 billion at end-June 2020. The buyback amount can be up to 10% of shareholder funds of the last audited financials (through a board-approved route). Alternately, the company can allocate a buyback amount of up to 25% of shareholder funds through shareholder approval via the tender route (15% of shareholder funds in case of the open market route). Our estimate of maximum outlay of buyback through the board-approved route is Rs 89 billion (0.9% of current market cap) or Rs 220 billion (2.2% of current market cap) through the shareholder-approval route. The company has gone through the tender route in the past for buyback of equity shares. Notably, Sebi restricts promoter participation in the open market route of buyback.

A premium to the spot price is necessary to incentivise shareholders to tender shares through the tender route. Assuming a 15% premium to October 5 closing price, TCS has headroom to buy back 1.8% of equity outstanding through the shareholder-approval process of the tender route. At a broader level, the share buyback price in the tender route is irrelevant as long as all shareholders participate in the offer. Investors in TCS will receive cash based on a simple formula, i.e. the proportion of holding in TCS X buyback size. Effectively, this is simply an alternative form of dividend payout. Should potential EPS dilution matter in such cases? We believe not.