Too Much Of A Good Thing

Reliance Infrastructure (R-Infra) announced on February 14, 2011 that it will implement the second round of its share buyback programme. It plans to spend maximum Rs1,000 crore on the buyback, while the maximum price it is prepared to pay is Rs 725 a share. The minimum number of shares that the company has committed to purchase is 34 lakh (which, at a maximum price of Rs 725 per share, will cost it Rs246 crore). On the other hand, the maximum number of shares it has committed to purchase is 1.37 crore.

Post buyback scenario
Post buyback, the company’s earnings per share (EPS) will get a boost of 5.4 percentage points. R-Infra will then have a Q3FY11 EPS of Rs 7.13 instead of Rs 6.77 as reported. Despite the buyback, the company would still report a 44 per cent fall in EPS in Q3FY11. If the buyback goes as planned, the promoter’s shareholding will rise beyond 50 per cent. Already this year the promoters have acquired 2.25 crore of shares at Rs 928.89 per share by converting warrants received through preferential allotment.

In hindsight
In February 2009, the company announced a two-phase share buyback plan. In the first phase starting February 25, 2009, it planned to buy Rs 700 crore worth of shares at Rs 700 apiece. But after buying the minimum number of shares stipulated in the offer, the company closed the offer on April 8, 2009. Earlier in 2008 also R-Infra (then called Reliance Energy) had done a buyback worth Rs 800 crore.
During earlier buybacks, the rationale R-Infra had offered was that it wanted to enhance shareholder value. This time it has said it is trying to protect the company’s share price from bear cartels, which it alleges are trying to hammer down the price of the stock. Over the last six months, R-Infra’s stock has lost -46.73 per cent value. The company’s standalone and consolidated book value are Rs 599.15 per share and Rs 860.63 per share respectively, vis-à-vis the prevailing price of Rs 615 per share. Hence, the management is trying to make the case that the stock’s market price does not reflect its true value.

Right or wrong?
Under normal circumstances, a buyback should be welcomed as long as it does not jeopardise the company’s growth prospects. But R-Infra seems to be stretching this notion a bit too far. This is its third buyback in four years. All of this makes one suspect that the buybacks are being undertaken to boost the company’s financial ratios such as EPS, RoE, etc. at a time when profitability has been declining every quarter since Q4FY09 (see graph).
On the positive side, in the last two years the company has transformed itself from a power company into a diversified infrastructure developer with a wider portfolio of projects. Consequently its capital work in-progress has increased threefold. But these new businesses are not yet the company’s major bread winners, as they contribute less than a fifth of its total revenue. Currently its order book stands at Rs 40,000 crore.
As for valuation, the stock is trading at a PE of 21.99, slightly more than its five-year median PE of 19.58. When compared to that of its peers, its valuation appears fair. As many as 12 of its projects (cost Rs17,400 crore) are expected to become operational in FY12, which will provide better revenue visibility.
In the final analysis, shareholders need to think hard about the company’s long-term prospects (which we think are sound). If you have faith in it, hold on to its shares for the long term. But if you are getting impatient, take up the buyback offer.