So let’s look at some basics of Share buyback to understand the rationale of such announcement:

What is Share buyback:
Basically, it is the purchase by a listed company of its own shares.
In what way(s) can we institute a Share buyback scheme:
Can be using the following ways:

• The most common is when a company buys shares on the open market. A company has to get approval from its shareholders during the Annual General Meeting in order to buy back its shares.

• Another one which is less common, is that a company can announce a tender offer. This involves all shareholders submitting a price they would be prepared to accept for their shares. In both instances once the company buy backs the shares it will cancel them, so they will cease to exist. Therefore a company cannot flog the same shares back onto the market at a later date.

Is share buyback something new in the market?
Share buyback has been here for long time. However, it’s popularity catapulted over the past twenty years. In the United States alone, corporate expenditures on share buybacks as a percentage of earnings are ten times higher today than there were in 1980. In the late 1990s, for the first time companies spent more money repurchasing their shares than on paying dividends. Share buybacks are also flourishing globally. In recent years, countries like the U.K. and Canada have seen an increase in activity while other nations that previous prohibited buybacks, including Germany and Japan, have adopted provisions to make them acceptable.

Why do or what are the reasons for companies to buy back their shares?

• To deploy excess cash flow and return it to shareholders as the management deem that they are unable to utilize these surplus cash to earn higher than the company’s cost of capital. In recent years, it is interesting to note that the fund managers or investment institutions favor companies to return their surplus cash rather than sitting on it just in case they might need it for future acquisitions. The institutions believe that it should be their decision, and not the company’s, to hold part of their assets in cash,

• To substitute dividend payouts with share repurchases, for tax reason purposes,

• In time of the depressed market where the share prices of the companies have been unnecessarily thrashed by the public, the management might deem it necessary to do a share buybacks of its shares so as to prop up or increase the share price. By the company’s entry into the market, firstly it create a demand for the share and also it’s add the necessary confidence or psychological impact to the public that the management is confident of the performance of the company

• To rationalize or to leverage the capital structure – the company believes it can sustain a higher debt-equity ratio,

• To manage its earnings per share.

Are there any advantages and or disadvantages in a share buyback scheme:
Advantages:

• it might enhance the confidence of its investors on the company’s board of directors,as these investors know that the directors are ever willing to return surplus cash if it’s not able to earn above the company’s alternative investment or cost of capital,

• it enhances shareholders value. Generally, share buybacks are good for shareholders. The laws of supply and demand would suggest that with fewer shares on the market, the share price would tend to rise. Although the company will see a fall in profits because it will no longer receive interest on the cash, this is more than made up for by the reduction in the number of shares.

Disadvantages:

• A buyback announcement can send a negative signal in these situations.

A typical example is the HP case:
From November 1998 through October 2000, the computer giant Hewlett-Packard spent $8.2 billion to buy back 128 million of its shares. The aim was to make opportunistic purchases of HP stock at attractive prices—in other words, at prices they felt undervalued the company. Instead of signaling a good operating prospects to the market, the buyback signal was completely drowned out more powerful contradictory signals about the company’s future which are an aborted acquisition, a protracted business restructuring, slipping financial results, and a decay in the general profitability of key markets. By last January, HP’s shares were trading at around half the average $64 per share paid to repurchase the stock.

• Buybacks can also backfire for a company competing in a high-growth industry because they may be read as an admission that the company has few important new opportunities on which to otherwise spend its money. In such cases, long-term investors will respond to a buyback announcement by selling the company’s shares.

• The share buyback scheme might become a big disadvantage to the company when it pays too much for its own shares. Indeed, it is foolish to buy in an overpriced market. Instead, the company should put the money into assets that can be easily converted back into cash. This way, when the market swung the other way and is trading below its true value, shares of the company can be bought back up at a discount, ensuring current shareholders receive maximum benefit. Strictly, a company should repurchase its shares only when its stock is trading below its expected value and when no better investment opportunities are available.

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Let’s understand some basics of venture capital:

(a) What really is venture capital?

• Venture capital is a form of “ risk capital” where the capital is invested in a project/business with substantial element of risk relating to the future creation of profits and cash flows.

• Furthermore, this “risk capital” is invested as shares (equity) rather than as a loan and the investor requires a higher”rate of return” to compensate him for his risk.

• They have the characteristic of long-term in nature and “committed” capital, to help unquoted companies grow and succeed.

There is a significant contrast between a loan versus venture capital funding.

In the case of a loan, the lender has a legal right to both interest and principal repayment irrespective of the success or failure of a business.

For the Venture capital, it is invested in exchange for an equity stake in the business. As a shareholder, the venture capitalist’s return is dependent on the growth and profitability of the business. This return is generally earned when the venture capitalist “exits” by selling its shareholding when the business is sold to another owner.

(b) What kind of business is attractive to venture capitalists?

Normally, venture capitalist can assist an entrepreneur when he/she is looking to:

• start-up,
• expand,
• buy-into a business,
• buy-out a business in which he works,
• turnaround or revitalise a company,

However, venture capitalist prefers to invest in “entrepreneurial businesses”. This does not necessarily mean small or new businesses. Rather, it is more about the investment’s aspirations and potential for growth, rather than by current size. Such businesses are aiming to grow rapidly to a significant size.

As a norm, unless a business can offer the prospect of significant turnover growth within five years, it is unlikely to be of interest to a venture capital firm. Venture capital investors are only interested in companies with high growth prospects, which are managed by experienced and ambitious teams who are capable of turning their business plan into reality.

Areas That Venture Capitalists Are Interested In:

• Internet
• Information Technology
• Semiconductors
• Electronics
• Telecom And Networking

(c) What usually is the length of investment in a business by venture capitalists?

Venture capital firms usually look to retain their investment for not more than five (5) years.

The term of the investment is often linked to the growth profile of the business. Investments in more mature businesses, where the business performance can be improved quicker and easier, are often sold sooner than investments in early-stage or technology companies where it takes time to develop the business model.

(d) Where do venture capital firms obtain their money?

Similar to any management teams vying for finance, venture capital firms raise their funds from several sources like pension fund, insurance companies, financial institutions ( note that many venture capital companies are actually subsidiary arm of financial institution)

Hence, venture capital companies also need to demonstrate a good track record and the prospect of producing returns greater than can be achieved through fixed interest or quoted equity investments.

Of course, there is always a back to back element when coming to venture capital companies’ investment preference. Don’t forget that they too are committed to return the investors’ original money plus any additional returns made. This generally requires the investments to be sold, or to be in the form of quoted shares, before the end of the fund.

(e) What is involved in the investment process?

The investment process, from reviewing the business plan to actually investing in a proposition, can take a venture capitalist anything from one month to one year but typically it takes between 3 and 6 months. There are always exceptions to the rule and deals can be done in extremely short time frames. Much depends on the quality of information provided and made available.

The key stage of the investment process is the initial evaluation of a business plan. Most approaches to venture capitalists are rejected at this stage. In considering the business plan, the venture capitalist will consider several principal aspects:

· Is the product or service commercially viable?

· Does the company have potential for sustained growth?

· Does management have the ability to exploit this potential and control the company through the growth phases?

· Does the possible reward justify the risk?

· Does the potential financial return on the investment meet their investment criteria?

In structuring its investment, the venture capitalist may use one or more of the following types of share capital:

Ordinary shares
These are equity shares that are entitled to all income and capital after the rights of all other classes of capital and creditors have been satisfied. Ordinary shares have votes. In a venture capital deal these are the shares typically held by the management and family shareholders rather than the venture capital firm.

Preferred ordinary shares
These are equity shares with special rights.For example, they may be entitled to a fixed dividend or share of the profits. Preferred ordinary shares have votes.

Preference shares
These are non-equity shares. They rank ahead of all classes of ordinary shares for both income and capital. Their income rights are defined and they are usually entitled to a fixed dividend (eg. 10% fixed). The shares may be redeemable on fixed dates or they may be irredeemable. Sometimes they may be redeemable at a fixed premium (eg. at 120% of cost). They may be convertible into a class of ordinary shares.

Loan capital
Venture capital loans typically are entitled to interest and are usually, though not necessarily repayable. Loans may be secured on the company’s assets or may be unsecured. A secured loan will rank ahead of unsecured loans and certain other creditors of the company. A loan may be convertible into equity shares. Alternatively, it may have a warrant attached which gives the loan holder the option to subscribe for new equity shares on terms fixed in the warrant. They typically carry a higher rate of interest than bank term loans and rank behind the bank for payment of interest and repayment of capital.

Venture capital investments are often accompanied by additional financing at the point of investment. This is nearly always the case where the business in which the investment is being made is relatively mature or well-established. In this case, it is appropriate for a business to have a financing structure that includes both equity and debt.

Other forms of finance besides venture capitalist equity include:

• Normal Banking facilities like overdrafts, short to medium-term loans at fixed or variable rates of interest;
• Merchant banks which organize the provision of medium to longer-term loans, usually for larger amounts than banks;
• Finance houses – various forms of installment credit, ranging from hire purchase to leasing, often asset based and usually for a fixed term and at fixed interest rates;
• Factoring companies – provide finance by buying trade debts at a discount, either on a recourse basis (you retain the credit risk on the debts) or on a non-recourse basis (the factoring company takes over the credit risk).
• Mezzanine firms – provide loan finance that is halfway between equity and secured debt. These facilities require either a second charge on the company’s assets or are unsecured. Because the risk is consequently higher than senior debt, the interest charged by the mezzanine debt provider will be higher than that from the principal lenders and sometimes a modest equity “up-side” will be required through options or warrants. It is generally most appropriate for larger transactions.

Making the Investment – Due Diligence

To support an initial positive assessment of your business proposition, the venture capitalist will want to assess the technical and financial feasibility in detail.

External consultants are often used to assess market prospects and the technical feasibility of the proposition, unless the venture capital firm has the appropriately qualified people in-house. Chartered accountants are often called on to do much of the due diligence, such as to report on the financial projections and other financial aspects of the plan. These reports often follow a detailed study, or a one or two day overview may be all that is required by the venture capital firm. They will assess and review the following points concerning the company and its management:

- Management information systems
- Forecasting techniques and accuracy of past forecasting
- Assumptions on which financial assumptions are based
- The latest available management accounts, including the company’s cash/debtor positions
- Bank facilities and leasing agreements
- Pensions funding
- Employee contracts, etc.

The due diligence review aims to support or contradict the venture capital firm’s own initial impressions of the business plan formed during the initial stage. References may also be taken up on the company (eg. with suppliers, customers, and bankers).

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Listed below are some of the reasons :

• their company‘s share prices have been grossly under-valued by the public/share market;
• to avoid public scrutiny especially with the onerous corporate governance and disclosure requirements;
• the initial objective of listing no longer provide any tangible benefits;
• to avoid assets strippers/predators who seeks the opportunities in public listed companies where their share prices are below their net tangible assets (particularly in property development and stock broking businesses);
• high cost of maintaining those onerous corporate governance and disclosure requirements;

Incidentally, it is never easy to embark on a privatisation exercise . The acquirer must ensure that the offer price is sufficiently attractive to minority shareholders to entice them to accept the offer. Otherwise, the acquirer runs the risks of seeing its proposal thrown out at a shareholder’s general meeting or the acquirer fails to obtain the minimum number of acceptances by minority shareholders for the privatisation to be successful.

Illustration of financial impact on Privatisation Exercise:
In this case the holding company is AB Holding Group which has two subsidiaries: Subsidiary A, a listed public company which is 55% owned and Subsidiary B, a private company which is wholly owned.

Assuming that AB Holding Group ‘s Board of Directors consider that the market/public has undervalued its group’s fundamental and its rightful price should be around the range of $14.50 (0.5 x average industry PER of 29) instead of $7.50 (0.5 x PER of 15 times).
Its Board of Directors decided to embark on its privatisation scheme by acquiring all the balance of the shares of Subsidiary A from the public.

By privatizing subsidiary A, its holding company AB Holding Group’s Earning per share (EPS) has now gone higher which it hopes that share price will go up higher perhaps to $12.00 level (0.8 x15)

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Append below are some of the following obvious advantages of taking a private company into a public listed status:

• Enhances profile and standing of the company;
• Access to capital market;
• Flexibility in sourcing funds;
• Ability to get cheaper funding due to public listed status;
• Greater visibility;
• Added value to share by increasing its marketability;
• Compliance with NDP

Interestingly, we also observed a similar growing trend of public listed companies contemplating to bring their companies or subsidiaries back to private status. [refer to article on company going private]
As mentioned, despite IPO/listing as the commonest key, Management needs also be clear before seeking listing and should at least consider the following factors when intending to go for IPO:

• Is the company able to withstand constant public scrutiny from the public;
• The responsibility towards public accountability as the investing parties are outsiders;
• Family controlled companies seriously might need to consider the dilution of their shareholding or control;
• The constant need to comply with strict legislation for example the announcement of sensitive matters, insider trading, complying with the time line on financial reporting;
• Review the cost of listing and “costs” of keeping good corporate governance.

Not forgetting that there have real life situation where after attaining public listed status, management find themselves no longer fanciful of the public listed status simply for the following reasons:

• When their companies were listed, it was in a robust share market environment but subsequently after that, when gloomy market situation prevails, their company‘s share prices have been grossly under-valued by the public/share market;
• The management is unable to take the onerous corporate governance and disclosure requirements;
• The initial objective of listing no longer provide any tangible benefits;
• To avoid assets strippers/predators who seeks the opportunities in public listed companies where their share prices are below their net tangible assets (particularly in property development and stock broking businesses);
• High cost of maintaining those onerous corporate governance and disclosure requirements

In Malaysia, there are some interesting like Astro, UDA Holdings who seeked public listing and immediately few years later go back to private. Of course, every listing and reverse gear of privatization can have many justifications but ultimately enhancing/maximising shareholder value should be the key consideration!

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Besides the above, the following are some of KEY REASONS for executing M&A:

1. Globalisation of business: Increased cross-border investments require companies in this region to remain competitive (e.g. minimise production cost and increase efficiency via maximising technology transfer). They may have to venture overseas to remain in business. Alternatively, companies may merge as a quicker way to grow bigger and stronger and to exploit synergies.

• Market positioning: Growth via M&A is seen in many instances to be quicker and cheaper than organic growth. M&A helps to capture a bigger market share or as a market penetration tactic.

• Synergy: Two or more companies’ joint effort would not only develop a competitive edge, but it can also introduce an additional earnings stream while reducing dependence on unreliable earnings sources.

• Broader strategy: Some companies undertake the merger and acquisition exercise to access new technology or to secure a source of supply or raw materials.

• Costs savings: Sometimes a company can save costs and achieve economies of scale by taking over or merging with another company.

• Opportunism: Where there is an opportunity, such as an increase in distressed or poorly managed companies in the market, it will surely prompt a strong company to take advantage of the situation to undertake a take-over or merger exercise

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So let’s lookat at some of these strategies that can form the blueprint/excuses for transformation are:-

• immediate divestment of non-strategic businesses,

• earmarking companies and assets for fund raising,

• retention and enhancement of selected core businesses,

• venturing into new core activities and

• rationalization of capital.

In reality, these are really tricks to entice further capital injection into those companies that have almost or already failed business. Dont you think that the aforesaid strategies are those that need to be done?

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So let’s look at what is Hiving-down?

It is the transfer of a business from an insolvent company owning it to a new subsidiary which is specially form for the purpose.

By doing so, there are advantages derived from it:

• It puts the continued trade into a company that does not suffer the stigma of being insolvent,

• It separates the task of clearing up the old company’s affairs from the continuation of the business,

• It avoids product liability claims falling on the Receiver or Liquidator personally,

• The new company forms a convenient package for sale to a purchase of the business.

It’s important to note that by doing this corporate restructuring of hiving-down, there is no change in beneficial ownership as the old company who previously own the business is now having shareholding in the subsidiary.

The hiving-down basically involve the sale of the business, goodwill and essential trading assets from the insolvent company to the subsidiary. There must not be any transfer of any liability hence there might be some assets excluded in the sale because they might be carrying potential liabilities. Also, some business are not sold to the subsidiary because of the pending of special registration requirements which might delay the transfers.

This hiving-down is recorded in a legal document where the legal agreement will at least includes the following:

• Definitions
• Sale and purchase of the assets
• Purchase consideration
• Time completion of the Sale and Purchase of the assets
• Employees involved
• Apportionment, pre-completion book debts and receivables
• Outstanding contracts
• Third party items and rights
• Exclusions
• Further assurance

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The belief is that by valuing as a stand alone entity instead of as a “bundle” within a group of companies, the value should then become more obvious and might reflect a more favorable value.

Basically, breakup strategies can be in various forms as illustrated below:

1. A divestiture is the sale of a piece of a company for example a division to another party. By doing so, this become a stand alone unit which will be easier to analyse and hopefully will fetch a higher added value to the seller,
2. In a spin-off, a parent company divests a business unit or subsidiary. This divestment is not sold for cash or securities. Instead, shares in the new company are distributed to the shareholders of the parent company on a pro-rata basis. Some examples of spin-off include Quaker Oats’ spin-off of its toy manufacturing subsidiary, Fisher-Price; General Motors’ spin-off of EDS and others,
3. An equity carve-out is a type of divestiture in which a parent company sells equity in one of its subsidiaries to the public through an initial public offering.(IPO)

Besides enhancing shareholder value, the intention of the parent company after divestiture, spin off or equity carve-out might be to leave itself as a “pure play” in its own core competency field/business.

A good illustration is the AT&T’s case:

In September 1995, AT & T announced that it would divide its operations into three publicly traded companies. In addition to AT&T, the communication services company, there would be a network systems company called Lucent Technologies and a computer company called NCR. To form Lucent, first there was an equity carve-out in which 17% of the new company was offered to the public through an IPO. The balance of 83% was distributed as tax-free to the AT&T shareholders.

With this carve-out of Lucent and spin off of NCR, AT&T now laid focus as a pure communication services company.

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So why did these companies failed and what are the ways that shareholder value are eroded/destroyed.

Tabulated below perhaps are some major reasons for a business to under-perform or to fail:

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Whether diversification is a right direction or not, Management needs to carefully review some critical questions before embarking on this strategy.

The below are extracted from Harvard Business Review on Strategies for Growth pertaining to some critical questions that managers need to review before embarking on diversification:

• What can our company do better than any of its competitors in its current market?

To diversify on some loose/vague decisions rather than on a systematic analysis of what sets their company apart from its competitors. By determining what they can do better than their existing competitors, companies will have a better chance of succeeding in new markets

• What strategic assets do we need in order to succeed in the new market?

Excelling in one market does not guarantee success in a new and related one. Managers considering diversification must ask whether their company has every strategic asset necessary to establish a competitive advantage in the territory it hopes to conquer.

• Can we catch up to or leapfrog competitors at their own game?

All is not necessarily lost if managers find that they lack a critical strategic asset. There is always the potential to buy what is missing, develop it in-house, or render it unnecessary by changing the competitive rules of the game.

• Will diversification break up strategic assets that need to be kept together?

Many companies introduce their time-tested strategic assets in a new market and still fail. That is because they have separated strategic assets that rely on one another for their effectiveness and hence are not able to function alone.

• Will we be simply a player in the new market or will we emerge a winner?

Diversifying companies are often quickly outmaneuvered by their new competitors. Why? In many cases, they have failed to consider whether their strategic assets can be easily imitated, purchased on the open market, or replaced.

• What can our company learn by diversifying and are we sufficiently organized to learn it?

Savvy companies know how to make diversification a learning experience. They see how new businesses can help improve existing ones, act as stepping-stones to industries previously out of reach or improve organizational efficiency.

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