The management of Dangote Cement announced recently that its board of directors had agreed to recommend a share buyback, as well as a reverse split to its shareholders for approval. Corporate finance historians in Nigeria will agree that, if approved by both the shareholders and the authorities, this may be the first time a Nigerian corporate body is going to undertake a share buyback as a corporate action. The reason why this looks like a first is that until now, Nigerian corporate law and governance had frowned at share buybacks. The reason is that those who crafted the corporate law in Nigeria had felt that such corporate actions could be abused. Be that as it may, if Dangote Cement goes through with its share buyback proposal, it will not only be a welcome development but will open the doors to other corporate entities that may wish to use share buyback as an instrument of corporate financial management.

What is share buyback?

A share buyback is an action where a company buys its own shares in the open market at the prevailing market price. It’s a kind of corporate financial management where, if a company has a lot of free cash flow, which it does not want to pay out as dividends, or does not have a more profitable avenue to invest in, it could decide to use the cash flow to buy back its own shares.

Why Share Buyback?

The question that readily comes to my mind, and I am sure that same question is running around the heads of shareholders and non-shareholders of Dangote Cement, is why would a company buy back its own shares? There are many reasons for carrying out this corporate action. As already noted, the main reason is corporate financial management.

Share Buy Back: The new corporate action in town

Market signal of undervaluation

Another reason is to give signal to the market that the shares of the company are undervalued. There is always a sort of principal-agent problem in corporate affairs with all the asymmetric information that goes with it. It is often believed that the board of directors know more than the shareholders about the financial and other conditions of an organization, such that the board knows when the company it is husbanding is undervalued, properly valued, or even overvalued. When a company’s board of directors thinks that the shares of the company are undervalued and therefore cheap in the market, it may become prudent to buy back the shares at such cheap prices. By so doing, a signal will be sent to the public that the company’s shares are cheap and should be bought. The downside here is the fear of manipulation. What if the board members are trying to hype up the prices by signalling that it is undervalued, with a view to selling their own personally held shares? This is where the abuse comes in. Therefore, the authorities should ensure that board members of Dangote do not sell their shares within a specified time after the share buyback. Dangote Cement has undergone some price reduction in recent times, so one may be correct in thinking that it is undervalued.

Reduction in dividend expense

Another reason that a company would engage in share buyback, which still stems from corporate financial management, is to reduce divined expense burden on its income statement. After the buyback, the stock bought become “treasury stocks”, with the effect that the outstanding shares become reduced by the amount which the company bought back. By so doing, the company now has less shares on which to pay dividends. Let us say that prior to the buyback, Dangote Cement had one billion shares issued and outstanding. If they declare a dividend of N1 per share, that will mean a payment of one billion Naira in dividend. What if the board decided to buy back four hundred million of those one billion shares? The company will only pay six hundred million in dividends if it declares a dividend of N1 per share, post share buyback.

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Financial window dressing

Another reason that a company would like to buy back its shares is what I may call financial cosmetology or window dressing. The financial health of a company is often judged by looking at its financial metrics with respect to the number of shares. Analysts, financial experts, and the not too financially savvy oftentimes talk in terms of earnings per share (EPS), and other per share metrics. By buying back some shares, a company may be able to reduce the denominator in the per share equation, thereby increasing the result, or quotient, as mathematicians will say. Let us say, as we noted already, that Dangote Cement has one billion shares outstanding. With a net profit of one billion Naira, that translates to an earnings per share of N1, but if the buyback results in a reduction to six hundred million shares, a one billion earnings will give rise to an earnings per share of N1.67, which is a more appetizing number than an EPS of 1.

Lack of growth opportunities

On the downside, a share buyback can be interpreted, and rightly so, to be due to lack of growth opportunities. If Dangote Cement, for example, has a profitable opportunity to invest the cash with which it intends to buy back the shares, why not do that and increase shareholder value by so doing. As noted in the introductory part of this piece, when a company is so awash with cash that it does not know what to do with it, and has no profitable investment to channel it into, what readily comes to mind is share buyback.

Share Buy Back: The new corporate action in town

Standard chartered

Conclusion

In spite of the reason for which Dangote Cement is engaging in the corporate action of share buyback, share buyback is a veritable tool in the hands of corporate CFOs for financial management, however, efforts should be made to ensure that it does not get abused. It has the ability to increase the liquidity and activity of the Nigerian stock market and should be encouraged.

Uchenna Ndimele is the President of Quantitative Financial Analytics Ltd. MutualfundsAfrica.com and mutualfundsnigeria.com (both Quantitative Financial Analytics company website) is a leader in supplying mutual fund information, analysis, and commentary on African mutual funds. We provide reliable fund data; and ratings information that will add value to fund managers, the media, individual investors and investment clubs.

2 COMMENTS

  1. Thanks for your comment. I did my research though, but if you feel that this is not the first, publish the historical trend for our education. That is why we are here, to educate each other.

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