Is buying back shares the best use of L&T free cash?

livemint.com:

₹10,000 crore to buy back shares at a maximum price of ₹3,000. It was announced when the stock price was around ₹2,565, and by close on Wednesday, it had risen to ₹2,652. Hence, the offer was at a premium of 17% to market price.

Here’s how a buyback works. Investors who wish to accept it offer up their stock holdings. The company buys these shares and extinguishes them, leading to fewer shares outstanding.

Since the equity base is smaller, any future profits work out to a higher earning per share. In theory, this should drive up valuations. There are, of course, terms and conditions attached.

There’s a record date – ownership of shares on that date is crucial. There’s also a ceiling on the total commitment of funds. If more shares are offered, there will be a “lottery" to decide how many shares per investor the company will buy.

This is called the acceptance ratio, and there is usually a quota reserved for retail investors. One key factor in offering a buyback is tax. The company pays 20% plus surcharge, amounting to about 23% of the buyback price.

The investor who sells shares in a buyback pays no tax. Most serious investors pay the top marginal rate – about 34.5% – on dividends received. They have to pay a minimum of 10% on long-term capital gains, so a buyback is clearly a better deal for the investor from a tax perspective, assuming there’s a profit.

Of course, by selling shares the investor will also forego future profits. Most investors will see this buyback as a parting gift from the company’s departing chairman, the legendary AM Naik, who is due to retire in September. The company is also handing out a special dividend of ₹6 a share.