Economy, Business And Markets

Treasury Stocks to Help Bolster Equity Market

Treasury Stocks to Help Bolster Equity MarketTreasury Stocks to Help Bolster Equity Market

Iran’s fast emerging economy, boasting the most diversified equity market in the region worth nearly $85 billion, is set to unleash part of its untapped potential through the launch of new instruments, among the most recent ones being the treasury stocks.

Treasury stocks are the portion of shares that a company keeps in its own treasury. They may have come from a repurchase or buyback from shareholders or may have never been issued to the public in the first place. These shares do not pay dividends, have no voting rights and are not included in shares' outstanding calculations.

Head of Securities and Exchange Organization, Mohammad Fetanat, recently said SEO was finalizing regulations on treasury stocks in accordance with the legislation on "removing barriers to competitive production and improving the financial system." The regulation is expected to be ratified by the High Council of Exchange Market in the near future.

"Once the treasury stocks make debut, a form of sukuk known as Murabaha will be issued to help the companies buy back their shares,” SENA quoted Fetanat as saying.

The new instrument makes the issuers responsible for share fluctuations, said Fetanat, adding that companies can allocate up to 10 percent of their capital base to buy back their own shares.

Capital base is acquired during an IPO or the additional offerings of a company plus any retained earnings.

There are, however, speculations that lack of liquidity could hinder the implementation of the new instrument. With the companies grappling with shortage of cash flow, banks being in a bad shape and balance sheets loaded with toxic debts, the listed companies may be reluctant to buy back shares.

However, according to Fetanat, "If the companies believe in their own shares, they will definitely embark on buybacks. He added that all listed companies may opt to forego purchase of treasury shares.

> Benefits and Pitfalls

Treasury stocks are often created after a company's shares are issued. In this case, some shares are kept in the company's treasury to be used for creating extra cash when necessary. Another motive may be for the company to keep a controlling interest within the treasury to help ward off hostile takeovers.

In addition, buybacks tend to drive up the price of the stock, since there are not as many shares left in the market.

Usually when the stock market is declining, there will be an increase in the number of companies announcing stock buybacks. The investing public often overlooks the potential value these announcements hold in helping them better analyze their trading.

More importantly, buyback signals that executives are confident the cash reinvested in a company will get a better return than alternative investments.

The Financial Tribune interviewed Stefan R. Kille, the CEO of German advisory company Aspian Invest, for more on treasury stocks.

Kille explained that treasury shares are bought and sold by many companies for market-making purposes, so that unfavorable ups and downs can be compensated by resorting to their own shares.

"Assuming that a company believes in itself, this is a good way to increase the return on cash and cash equivalents," said Kille.

As no dividend is paid on own shares, holding such shares is generally a good way to increase earnings per share at constant total dividend volume, he added.

Another advantage of holding and trading treasury shares is benefiting from a possible knowledge projection (insider trading). However, insider trading could have negative impacts on the equity market, he noted.

"The main reasons why German companies opt for stock buybacks are first because it allows them to use their excess liquidity through purchase of treasury shares, and second because it helps them to optimize their capital structure," said Kille, adding that repurchase of own shares for the purpose of issuing employee shares is another advantage.

He also referred to the potential pitfalls of buybacks, observing that when a company's liquid assets are converted to treasury shares, they are no longer available for covering the company's debts. "If an undertaking which holds a lot of its own shares goes bankrupt, then these shares can no longer be liquefied for debt coverage," he explained.

The bottom line is stock buyback programs take advantage of supply and demand by reducing the number of shares outstanding, increasing earnings per share value, float and ultimately the price of the stock. In addition, it is considered a wise way of using excess cash. However, extensive research is recommended before a company embarks on purchasing its own shares.