Share repurchases and scrip issues - Buybacks and value per ...

Learning Outcomes

After reading this article, you will be able to explain the reasons for share repurchases and scrip issues, describe how buybacks and scrip dividends affect the number of shares and value per share, and assess their implications for shareholder wealth. You will also learn to calculate theoretical ex-rights prices and understand the treatment of these actions in the exam.

ACCA Financial Management (FM) Syllabus

For ACCA Financial Management (FM), you are required to understand the role and accounting effects of share repurchases and scrip issues. This article focuses on:

• The mechanics and motives for share buybacks and scrip (bonus) issues
• The impact of share repurchases and bonus issues on share price and earnings per share (EPS)
• Calculations involving theoretical ex-rights price following scrip or bonus issues
• The effect of these actions on shareholder value and exam-style analysis

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the primary difference between a share repurchase (buyback) and a scrip (bonus) issue?
2. True or false? A scrip issue increases the value of each share in issue, all else equal.
3. Which one of the following usually happens as a result of a company buying back its own shares? a) Total number of shares in issue falls
   b) Earnings per share decreases
   c) Market capitalisation always increases
   d) Share price is unaffected
4. Briefly explain why companies might choose to pay a scrip dividend instead of a cash dividend.

Introduction

Companies may adjust their capital structure and reward shareholders through methods other than simple cash dividends. Two common ways are share repurchases (buybacks) and scrip (bonus) issues. Both alter the number of shares in issue and can affect key measures such as share price and earnings per share (EPS). Proper understanding of these actions is important for both finance professionals and ACCA candidates, especially when required to analyse their impact on shareholder value.

Key Term: Share repurchase (buyback)
When a company buys back its own shares from existing shareholders, reducing the total number of shares in issue.

Key Term: Scrip (bonus) issue
An issue of new shares to existing shareholders, free of charge, in proportion to their current holdings.

The Mechanics and Motives

Share Repurchases (Buybacks)

A share repurchase involves a company buying back some of its own shares, either through a tender offer to all shareholders, open market purchases, or a specific offer to certain holders. This reduces the total shares in issue.

Common reasons for buybacks:

• To return surplus cash to shareholders
• To support the share price if perceived as undervalued
• To improve EPS (since profits are now spread over fewer shares)
• To adjust the capital structure by reducing equity and increasing gearing

Key Term: Earnings per share (EPS)
Profit after tax attributable to ordinary shareholders divided by the weighted average number of shares in issue during the period.

Scrip Issues (Bonus Issues)

A scrip (bonus) issue is the offer of additional new shares to existing shareholders, usually in a specified ratio (e.g., 1-for-4), with no cash payable. Scrip dividends occur when shareholders are offered the choice between taking their dividend as additional shares or in cash.

Key features:

• No change to total market capitalisation or shareholder wealth at the instant of the issue
• Share price typically falls in proportion to the increase in shares
• Individual shareholders end up owning more shares, but each worth less

Worked Example 1.1

A company has 1,000,000 shares in issue trading at $4. The company announces a 1-for-4 bonus issue.

1. How many shares will be in issue after the bonus?
2. What should the new theoretical share price be, assuming no other change in value?

Answer:

1. A 1-for-4 bonus issue means each shareholder gets 1 new share for every 4 held. There will be 1,000,000 / 4 = 250,000 new shares. New total: 1,250,000.
2. Total market value before = $4 × 1,000,000 = $4,000,000. After bonus issue, same market value, more shares: $4,000,000 / 1,250,000 = $3.20 per share.

Worked Example 1.2

Southfield Co has 500,000 shares in issue trading at $8 each. It uses $400,000 of surplus cash to repurchase shares when the share price is $8. Calculate:

1. The number of shares repurchased.
2. The number of shares remaining.
3. The effect on EPS if annual profit after tax is $1,000,000.

Answer:

1. $400,000 / $8 = 50,000 shares repurchased.
2. 500,000 – 50,000 = 450,000 shares remain.
3. EPS before = $1,000,000 / 500,000 = $2.00.
   EPS after = $1,000,000 / 450,000 = $2.22 (all else constant).

Buybacks and Value per Share Effects

When a company repurchases its own shares:

• The number of shares in issue falls.
• If profits remain unchanged, EPS increases.
• The share price may rise if the market views the buyback as a positive signal (indicating undervaluation or surplus cash).
• In theory, the total value returned to shareholders (via buybacks plus remaining equity value) equals the original, subject to taxes and transaction costs.

If the buyback is made at a premium to market price, those remaining may gain at the expense of those selling—depending on the price paid.

Effects on Shareholder Wealth

• If the company pays more than fundamental value for the shares, remaining shareholders could lose.
• If the company pays less, remaining shareholders could gain.

Scrip Issues and Value per Share Effects

The key outcome of a scrip/bonus issue:

• Shareholders own more shares, but each is worth less.
• The total value of each shareholder’s holding is unchanged immediately after the issue.
• Common exam calculations involve finding the theoretical ex-rights price or the change in EPS.

Key Term: Theoretical ex-rights price
The expected share price after a rights or bonus issue, calculated as (total value of shares before the issue + proceeds from new shares, if any) divided by the new total number of shares.

Worked Example 1.3

Vega Co has 2,000,000 shares at $5 each. The company makes a 1-for-5 bonus issue.

Calculate:

1. Number of new shares issued.
2. Total shares in issue after the bonus.
3. Theoretical ex-bonus price per share.

Answer:

1. 2,000,000 / 5 = 400,000 new shares.
2. 2,400,000 shares after.
3. Total market value unchanged: 2,000,000 × $5 = $10,000,000
   Ex-bonus price = $10,000,000 / 2,400,000 = $4.17 per share.

Exam Warning

Do not assume a bonus or scrip issue increases shareholder wealth. The market value per share falls in proportion to the increase in shares, so the total value held remains unchanged, except for minor rounding effects or market perception.

Comparison Table: Buybacks vs Scrip Issues

Revision Tip

For exams, focus on calculating theoretical ex-rights/ex-bonus prices and explaining the effect on EPS and shareholder wealth, not just the mechanics.

Summary

Share repurchases reduce the number of shares and tend to increase EPS, but if the repurchase is at market value, shareholder wealth stays the same. Scrip issues (including bonus issues and scrip dividends) increase the number of shares, reduce the share price and EPS, but do not change the total value held by shareholders. Both actions are neutral for shareholder wealth when no other variables change, though market reaction and tax may introduce small effects.

Key Point Checklist

This article has covered the following key knowledge points:

• Differentiation between share buybacks and scrip (bonus) issues
• Calculation of the theoretical ex-rights/ex-bonus price
• How buybacks affect EPS and value per share
• How scrip issues affect share price and shareholder wealth
• Key exam methods for analysing buybacks and scrip issues

Key Terms and Concepts

• Share repurchase (buyback)
• Scrip (bonus) issue
• Earnings per share (EPS)
• Theoretical ex-rights price