L&T Buyback

What exactly could have driven the buyback by L&T?

During the previous week, L&T announced its first ever buyback in history. The issue was also the third largest buyback in India, with the two largest tranches having been already completed by TCS. That raises a critical question. Buybacks are understandable for tech companies with mountains of cash and zero debt. But L&T has a small cash pile of less than Rs.9,000 crore and it has a debt of Rs.75,000 crore. Why would a company like L&T want to do a buyback in the first place? There could be 3 possible reasons.

Giving a signal to the market

If one looks at the price performance of L&T, it was a stark outperformer during the bull market of 2005-2007. However, post-2011, the stock has been a consistent underperformer after the capital cycle turned negative in India. While the stock has bounced from lower levels, the company needed to give a clear signal that the company was fully poised to make the best of the turnaround in the capital cycle. Secondly, L&T is making a conscious decision to shift from an asset-dominant model to an asset-light model. That can be best achieved by signaling through a buyback that the company did not really anticipate a major capital outlay. At this juncture, the buyback will not only enhance the ROE of L&T but also hint at a more futuristic and restructured model for L&T in the years to come. That is exactly what the buyback conveys.

Quick boost to ROE…

One of the big worries for L&T when it comes to its business model has always been the low levels of ROE. This decision to buyback 6 crore shares at Rs.1500 per share will entail an outlay of Rs.9000 crore and will shrink the equity of L&T by 4.29%. This will boost the ROE of the company by nearly 200 basis points. This is likely to be a strong signal that the ROE is likely to gradually head up further as L&T manages its transition to an asset-light model. L&T has always looked richly priced due to its low ROE. This focus on ROE could change that and ideally give it a rerating in the market. The buyback could just be the first step for the company.

It’s essentially about control…

The real issue here could be control issue and to prevent any hostile bids. With a large defence franchise, L&T was always in the eye of the predators. Hostile takeovers are nothing new to L&T. In the past, Reliance and Grasim tried it with limited success. L&T is a professional company without a promoter group. The largest shareholders are LIC and the Employee Trust who own the chunk of L&T. When you do a buyback you reduce the capital and trigger 5% limit sooner. Also, taking cash out of the balance sheet makes the company less attractive to suitors. That could be the real big reason behind this buyback program by L&T!

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