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Tuesday, 17 May 2022

Zydus Lifesciences Limited – Buyback Offer 2022 – vrk100 – 17May2022

Zydus Lifesciences Limited – Buyback Offer 2022 – vrk100 – 17May2022

(Updates dated 16Jul2022, 14Jun2022, 24May2022, 23May2022 and 20May2022 are available below)

(This is for information purpose only. This should not be construed as a recommendation. Please consult your financial adviser before taking any dive. Even though this blog was posted on 17May2022, I'll be updating this blog regularly with new information till the closure of this buyback offer, which may be some months away.)

1. Zydus Lifesciences Limited (ZLL hereinafter) on 17May2022 announced, through a BSE stock exchange filing, that its board of directors would meet on 20May2022 to consider a proposal to buy back the company's equity shares. The details of the buyback proposal will be known after the board’s meet on 20^th of this month.

The announcement was made after closure of market hours on 17May2022. The stock would react positively to the buyback news tomorrow. Zydus Lifesciences is earlier known as Cadila Healthcare. The name change was effected in Feb2022.

(story continues below)

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Read more on other buyback offers:

Great Eastern Shipping Company Ltd

Kaveri Seed Company Ltd

FDC Limited

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2. The buyback proposal is curious from a few angles. First, the promoters’ share in ZLL is already 74.88 per cent of total equity. As per rules, promoters cannot hold more than 75 per cent in a listed company. The maximum the company can undertake buyback is for 0.12 per cent—which amounts to nearly 12,72,500 shares. The paid-up share capital of the company as on 30Sep2021 is 102,37,42,600 equity shares of Re 1 each.

3. Second, the company’s debt-equity ratio is 0.29 with a gross debt of Rs 4,653 crore (data end-30Sep2021), after considerable debt reduction due to an exceptional gain of Rs 2,492 crore for the company in Jul-Sep2021 quarter after the sale of its Animal Health Established Markets Undertaking.

Of course, the liquidity profile of the company is decent as the net debt is manageable (cash & cash equivalents are Rs 3,640 crore as on 30Sep2021). The full picture of the balance sheet and profit & loss account as on 31Mar2022 will be known once the quarterly results are announced on 20May2022.

4. Based on the half-yearly cash flows as of 30Sep2021, it can be surmised that the company’s annual cash flows will be more than Rs 2,800 crore, as such the current gross debt is not worrisome.

In 2018 / 2019, Zydus Wellness Ltd (a subsidiary of ZLL) and Zydus Lifesciences (then Cadila Healthcare) jointly acquired Heinz India consumer business (with brands, like, Glucon-D and Complan) for Rs 4,595 crore. To fund the deal, Zydus Wellness raised fresh equity shares (refer page 30 of annual report) through a private placement—in which ZLL participated (as promoter of Zydus Wellness) with a total amount of Rs 1,175 crore.

Which Buyack Route?

5. Of the two routes available for share buyback, the company is unlikely to do buyback through ‘tender offer’ route. Let me explain. There are two scenarios in the first route: the first is where promoters will participate in the buyback offer and the second is promoters will decide not to participate in the offer.

If the board decides to use the first scenario, they can’t buy more than 12,72,500 shares lest they breach the 75 per cent maximum promoter stake allowed by norms. If the buyback is Rs 450 or Rs 500 per share, they can’t use more than Rs 64 crore for the buyback. Why such a big company would resort to such a low buyback amount?

6. Assuming that the board uses the second scenario, they can use higher amount, say Rs 500 crore or Rs 800 crore (this is just a wild guess), without promoters’ participation in the offer (in which case, the promoters’ stake would remain constant at the current 74.88 per cent). My informed guess is the company may not use the second scenario also, as the cost of buyback is likely to be higher (entailing the company to buy back at a fixed price) versus the second route described below.

7. The company will be left with the second route for buyback, that is, through stock exchange mechanism. If ZLL’s board decides to undertake buyback through stock exchange mechanism, ZLL’s promoters cannot participate in the buyback offer as shares would be bought directly from stock exchange (in which case, promoters’ share would remain constant at 74.88 per cent).

8. My considered view is the board will choose the second route, that is, buyback through stock exchange mechanism. Given the above possibilities, the stock reaction tomorrow will be muted.

The actual reaction would be on 20May2022 when the board announces the buyback route, buyback price and buyback size and other details. If the details come after the market hours on 20May2022 (Friday), the stock would react next Monday, that is, 23May2022.

Current valuation reasonable?

9. The current market price is Rs 349 as at close of 17May2022, with a market cap of Rs 35,700 crore. The stock is down 48 per cent from its 52-week high. Obviously, the company management thinks the share price is attractive for a buyback.

The stock price-earnings ratio is 7.5, price to book ratio is 2.2 and price to sales ratio is 2.4 as at close of 17May2022 (on a consolidated basis). On a historical basis, the current valuation ratios are below normal.

10. Using moderate debt as part of prudent capital allocation allows a company to reduce taxes leading to higher tax efficiency and greater cash flows. From this perspective, spending some reasonable money on buyback is not a bad idea given the decent liquidity profile of the company and the current valuation levels of Zydus Lifesciences.

Update 20May2022

11. As scheduled, Zydus Lifesciences' board of directors met on 20May2022 and made a raft of announcements, among others, fourth quarter results, buyback size of Rs 750 crore, buyback price of Rs 650 per share, dividend of Rs 2.50 per share and others. The announcements were made during market hours. Initially, the stock reacted negatively to the fourth quarter (Jan-Mar2022) results, which were not good.

Later, the stock price bounced back and closed for the day with a gain of 5.5 per cent for the day. The closing price on 20May2022 is Rs 357 per share, with a market cap of Rs 36,560 crore.

12. On 17May2022, I opined (see para 8 above) the company's board would choose the buyback route of 'stock exchange mechanism via stock exchanges.' But contrary to my expectations, the board decided to buy back shares through 'tender offer.'

My opinion expressed in para 8 above went wrong for the following reasons: I missed the point that when promoters choose the option of surrendering all the eligible shares (proportionately) via 'tender offer' route, their total stake in company would remain stagnant at 74.88 per cent.

If the promoters decide to utilise the option of surrendering 100 per cent of their eligible shares, they would have the option of surrendering nearly 85,96,000 shares with them.

That means they would get Rs 558.74 crore (85.96 lakh shares times 650) of the total buyback size of Rs 750 crore. So the biggest beneficiary of the buyback proposal is none other than the promoters!

Curiously, the company is giving a dividend of Rs 2.50 per equity share, in addition to the buyback. Through dividend, the company will return nearly Rs 256 crore to all shareholders, including the promoters.

Tax Distortions

13. Due to the distortions created by PM Modi government regarding taxation of dividends and buyback taxation (Tweet dated 06Jul2019), companies in India have been increasingly choosing the option of share buyback rather than dividend to increase tax efficiency for the promoters.

The buyback tax to be paid by the company buying back its shares is 20 per cent (including surcharge and cess, it is 23.30 per cent Tweet dated 01Mar2020).

In most cases, the promoters of companies (in the highest tax bracket) will have to pay, as individuals, a marginal income tax of 42.74 per cent (Tweet dated 07Aug2019), including surcharge and cess.

As a result of the huge advantage of paying buyback tax versus marginal income tax, the promoters in most of the cases have been choosing the buyback route for distribution of cash to shareholders, rather than the tax-inefficient route of dividend payments.

14. There has been a lot of flip-flop by PM Modi government on the taxation of dividends and buybacks. Arun Jaitley as finance minister introduced, effective FY 2016-17, 10-per-cent dividend tax in excess of Rs 10 lakh dividend received in a financial year (Tweet dated 21Mar2019)--this was subsequently removed. As of now, all the dividend income is to be included, effective FY 2020-21, in one's income.

Dividend distribution tax (DDT) was abolished effective 01Apr2020 (Tweet dated 26May2020).

Sorry for the digression, let us come back to the current topic, that is, Zydus' buyback. The company, in my opinion, has tried to offset the effects of bad fourth quarter results on stock price (which has already been under severe knock this year) by trying to blend it with a buyback proposal. Going by the first day's positive reaction at least, the stock market shrugged off the bad results and reacted positively to the buyback proposal by the end of the market hours today.

15. Details of the buyback proposal:

i) Maximum buyback price: Rs 650 per share

ii) Total shares to be bought back: 115,38,461 shares representing 1.13 per cent of total equity share capital

iii) Total buyback size: Rs 750 crore

iv) Buyback route: 'tender offer' route

v) The record date for deciding the shareholders entitled for share buyback is 02Jun2022 (ex-date 01Jun2022)

vi) As the buyback route is through 'tender offer,' the promoters have the option to participate in the buyback as per Buyback norms. And promoters have expressed their intention to participate in the buyback.

vii) If the non-promoter shareholders surrender all the eligible shares in the buyback, the free float will come down from current 25,72,08,166 shares to 25,42,65,680 shares post-buyback; and the total shares will fall from 102,37,42,600 to 101,22,04,139 shares.

16. To the best of my knowledge, the company has never made a buyback of its equity shares before.

Update 23May2022

17. On 21May2022, Zydus submitted a copy of board resolution dated 20May202 approving the buyback offer.

Key highlight from the above:

- buyback size of Rs 750 crore represents 6.85% and 4.36% of the aggregate of the total paid-up capital and free reserves as per standalone and consolidated balance sheet as on 31Mar2022

Update 24May2022

18. On 24May2022, Zydus made a public announcement on the buyback of equity shares.

Key highlights from the above:

- 15% of total shares proposed to be bought back are reserved for small shareholders

- small shareholders are those with shares valued at not more than Rs 200,000; based on the closing market price of the share on BSE and NSE having the highest trading volume as on the record date (02Jun2022)

Update 30May2022

19. The company on 30May2022 filed, with stock exchanges, a draft letter of offer for the buyback programme.

Update 14Jun2022

20. Zydus Lifesciences on 13Jun2022 filed a Letter of Offer for buy back of its equity shares.

Brief details: The open offer (tender offer route) opens on 23Jun2022 and closes on 06Jul2022.

Update 16Jul2022

21. Zydus Lifesciences on 16Jul2022 filed a post-buyback public announcement declaring the closure of the buyback.

A total of 115,38,461 equity shares were bought back via tender offer route at a price of Rs 650 per share totaling Rs 750 crore.

The details of the pre-buyback and post-buyback shares are as follows >

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Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.

Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.

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Tuesday, 29 September 2020

Possible Reasons for Dividend Income Cut-VRK100-29Sep2020

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During this financial year 2020-21, Indian listed companies have declared lower dividends as compared to the same period last year. Actually, companies should have distributed more of their profits to investors this year, after corporate tax rate were cut in September 2019 and dividend distribution tax (DDT) was abolished in February of this year.

But it is not so. Some possible reasons why dividend income from listed companies in India has come down substantially during the half-year ending 30 September 2020:

Post the outbreak of Corona Virus, Indian companies like their global peers want to conserve capital in order to face the turbulent times ahead. Due to severe lockdowns imposed by the central and state governments, economic growth has slumped impacting the revenues and profits of companies and incomes of households severely.

With a view to conserving their capital, corporates have been giving lower dividends this year. This is a big blow to investors in a situation when their incomes are already down due to job losses and wage cuts.

Reserve Bank of India (RBI) has barred banks from declaring any dividends for the financial year 2019-20, which they would have declared after 01 April 2020 had the RBI not barred them from dividend declaration. As a result, no bank has declared any dividend in this financial year so far.

In April of this year, RBI barred banks from declaring dividends due to uncertainty after Corona Virus outbreak, so that banks would conserve their capital. RBI will assess this ban after the declaration of second quarter (Jul-Sep2020) results.

In February of 2020, Government of India abolished dividend distribution tax (DDT) and made dividends distributed by companies taxable in the hands of investors from 01 April 2020.

Due to abolition of DDT, many companies declared interim dividends between 01Feb2020 and 31Mar2020, so that promoters and minority shareholders in higher tax brackets could avoid paying tax on dividend for the year 2019-20.

Tax laws change behaviour of companies and individual tax payers. India is notorious for its capricious laws, leaving investors panting for breath all the time.

As many companies declared interim dividends liberally between the start of February and end of March 2020, they have chosen not to pay any final dividend after 01 April 2020.

Anecdotal evidence suggests that almost fifty percent of listed Indian companies that ordinarily pay dividend during April and September of every year have not paid any dividend during April-September 2020 period.

Due to the Corona Virus outbreak, even traditionally well-paying firms have not declared any dividends in order to conserve cash for tough times ahead.

It may be noted several companies that ordinarily not borrow money or companies with low debt are forced to borrow money for working capital and other needs, as their sales have suffered drastically post-COVID-19.

Many companies complete paying dividends before the end of September every year. Software (Information Technology) companies and some other companies traditionally pay dividends three or four times in a year.

Even some mid-tier IT companies too have not paid any dividend after April 1st of this year.

It would not be incorrect to say that companies should have paid 15 to 20 per cent more dividend than previous year as DDT stood abolished since 01 April 2020 and corporate tax rates were cut by Government of India in September 2019; but strangely nearly half of companies have not bothered to declare any dividend after 01 April 2020 for the reasons suggested above.

Top 500 companies are supposed to have a dividend distribution policy as per law. Even though they have a policy, companies have not considered it appropriate to explain why they have not declared dividends in the first half of this year.

Instead of getting more dividend, investors are left with dividend income getting slashed by 20 to 35 per cent during the first half of 2020-21 depending on the mix of listed companies they hold.

It is hoped this nasty surprise, though not wholly unexpected, slapped on investors should get corrected during the next one or two years depending on the speed of upturn in the economy.

Many big companies have not announced any buybacks in recent quarters after the abolition of DDT and introduction of buyback tax. Share buybacks / repurchases are one form companies choose to return their excess cash to investors.

Companies now have to deduct tax at source (TDS) on dividend income, before distributing them to investors. The TDS rate is 10 per cent, but cut to 7.5 per cent till March 31, 2021 due to the pandemic.

If total dividend for a single investor exceeds Rs 5,000 in a financial year, a company has to do TDS on the total dividend at rates mentioned above. A company will apply dividends declared in the preceding financial year, while determining the limit of Rs 5,000 for TDS on dividends.

A few companies declared higher dividend this year. One such example is Lupin Limited. With a view to compensating shareholders due to dividend becoming taxable in investors' hands effective 01 April 2020, the company recommended higher dividend of Rs 6 per equity share as against Rs 5 of the previous year.

Across the globe, stock investment strategies based on dividend yield are out of favour. Discount cash flow (DCF) methods based solely on dividend have stopped working. The current trend is that more of total gains for investors come from share price increases rather than dividends.

(Please see comments below)

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Update on 08 October 2020: The article is updated with the following table giving details of dividends declared by select companies: