If you haven’t been in the market for long, terminology and actions within it can seem confusing. Take a share buyback for example.
This term means that a company will buy some of their own shares trading in the market. But why would a company do this? They already own themselves, so why are they buying what they already have?
To explain this concept, let’s go back to the absolute basics.
When you buy shares in a company, what you are really buying is ownership. You and every other shareholder in that company now own it. The majority of you have elected the board of directors in order to run your company.
Therefore, when your company makes a profit, you are entitled to the proceeds. But in order to make a profit, the company needs to spend money on their operations.
Let’s say the company has a biotechnology product.
The company has to spend money on research and development (R&D). They need to see how effective it is and how it should be used. They also have to spend money on manufacturing, a supply chain and marketing.
Basically, the company needs to spend money in order to make a profit. So how does this company get the money in the first place? From issuing shares to investors. If you bought shares in an initial public offering (IPO), your money will be funding the company’s operations.
So in order to fund themselves, a lot of companies choose to raise capital, or issue shares. They can do this in the form of a private placement, or they can offer a rights issue. The first involves issuing shares to large private investors. The second involves issuing shares to existing shareholders.
However, after a while, shares start to pile up. Shareholding could be diluted, and too many shares could be present within the market.
This is when companies usually elect to perform a share buyback. And by buying their own shares, companies reduce the amount of shares available on the market.
This action causes share prices to trade up, as the companies’ buying puts upwards pressure on shares. And it can also be a good way for companies to invest additional capital.
CSL Limited’s Share Buyback
Generally speaking, buying back shares is seen as a good thing for companies to do. And it’s exactly what biotech company CSL Ltd [ASX:CSL] plans to do.
CSL is currently buying back US$1 billion of their shares, which was unveiled in October last year. And now the biotherapy leader is planning to buy back an additional AU$500 million.
So what was CSL’s reason for an additional share buyback?
Along with earnings, CSL announced their plans to raise US$500 million in private placement. These funds are expected to be ploughed into their extensive operations. ‘It’s more just managing the cash; we’re still, I think, appropriately leveraged as an organisation,’ Paul Perreault said, chief executive of CSL.
And it is likely this is the main cause that will trigger the above share buyback. Reducing the risk of minority shareholders gaining majority stakes and reducing dilution is probably a good move by CSL.
However, investors still sold the big biotech firm down today. Shares opened down 6.2% this morning, to $109.4 per share. It’s likely that shares will recover. And with a share buyback plan in the works, this will again put more upwards pressure on the share price.
Junior Analyst, Money Morning
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