buyback paradox at Infosys

Former CFOs of Infosys, who are also major shareholders, are seeking buyback from Infosys board in order to ensure proper use of its cash. They are right in questioning its capital allocation policies. 

That said, whether Infosys should initiate a buyback is a tricky matter. For a buyback to make sense, two conditions should be met. 

First, the firm should have excess cash. The business should be in a position to generate cash in excess of its reinvestment requirements. That happens when growth slows down, and it becomes a mature business. It looks like Infosys does have excess cash; it had Rs.345 b as of March 2016. This cash becomes free cash flow to equity investors if it cannot be used for working capital, capital expenditures, or acquisitions. The Infosys board should first assess whether it is the case; recall the CEO's grand plans for 2020. 

Second, the stock price should be lower than its intrinsic value. The value changes based upon the perception of the analyst though.

Price > Value: The former CFO considers that the stock price is expected to be lower, and consequently, generating lower returns to the shareholders; this is when the stock price is higher than its value. If the board agrees with this analysis, but carries out a buyback, which is usually at a premium to the market price, it would mean that cash is being used for a stock that had no growth prospects. This would bring down the value of Infosys as a business because of the purchase of an expensive stock. Any buyback of the stock would hurt the remaining shareholders, and therefore is not good for the firm. 

A better option for the CFO would be to sell the (expensive) stock at market price, and exit as a shareholder. Invest the proceeds in opportunities yielding higher returns. This will be good for the exiting shareholders, remaining shareholders, and the business itself.

Value > Price: If the board does not agree with the CFO's analysis, and considers that value of the stock is higher than its market price, the buyback makes sense. There is excess cash, and the stock price is cheap compared to its value. If the board carries out the buyback, the exiting shareholders (the CFO and company) would be worse off. This is because the stock having prospects of higher returns is exchanged for cash by the exiting shareholder. This would no doubt help the remaining shareholders; and that is the whole purpose behind a firm undertaking stock buybacks. 

A better option for the CFO then would be not to sell the cheaper stock back to the firm. Stay invested when the value is higher than price.

Whoever is right in assessing the value of the business will be the winner in this game. Heck, isn't this the case in any investment game?

Stock buybacks after all are dividend decisions. When there is excess cash, and assessing value of stock is difficult (if so the managers are not fit to run the business is another story), there is a much better option for the board. Payout higher cash dividends; even normal payouts accompanied by a onetime special dividend will be good.

Dividends are good!