City law in practice Share buybacks

As Burberry plans to return 250m to shareholders, Husnara Begum looks at the mechanics of the share buyback facility and how it has developed over the years

Burberry is one of many companies that over recent months have announced plans to return value to their shareholders typically because they are sitting on wads of cash for which they have no immediate use, having shopped around for investment opportunities.

But as the M&A cycle turns, Herbert Smith corporate partner Greg Mulley says: “Chief executives may find more opportunities for growth or acquisitions which they consider to be a better use for their companies of any surplus cash provided the opportunity is seen as value for money.”

Burberry, for instance, launched a share buyback because the company had generated more cash than expected since it floated on the London Stock Exchange (LSE) in 2002 and because it failed to identify any major acquisitions that might have swallowed up the cash.

A company may also do a share buyback to:

  • Simplify its share structure.

  • Enhance the earnings per share (if a company has fewer shares in issue, then each share will attract a bigger dividend).

  • Adjust gearing (or debt/equity ratio).

  • Remove a troublesome shareholder.

    Share buybacks (or repurchases) are the most popular and simple method of returning value to shareholders. Once a company buys back a share from a shareholder, the share is cancelled and the shareholder is removed from the companys register.

    There are, however, some other rather complex structures for returning value to shareholders (see below), which were mostly designed to avoid the Advance Corporation Tax (ACT) that a company was historically required to pay on a share buyback.

    Burberrys share buyback

    Burberrys share buyback will comprise a combination of on-market purchases, which will run through to March 2006, and off-market purchases, which will enable the companys former parent GUS to retain its 66.5 per cent stake.

    On-market repurchases

    Listed companies will invariably carry out market share buybacks on the LSE. But a company is only able to make on-market repurchases if it has sufficient distributable reserves (ie profits), as defined in the Companies Act 1985, and relevant permission from its shareholders to do so.

    Companies typically obtain the authority to carry out on-market share buybacks by getting their shareholders to pass a resolution to that effect at their annual general meetings (AGMs). The ordinary resolution will stipulate the maximum number of shares the company is permitted to repurchase (this is typically between 5 and 10 per cent of the number of shares the company has in issue). The price at which a company repurchases its shares are also set out in the resolution and will be between the nominal value and, typically, a maximum of 105 per cent of the companys average share price during five days of trading.

    Burberry, for instance, intends to make on-market repurchases on the back of the companys existing general authority, which was given by its shareholders at the last AGM in July 2004. The current authority, which allows Burberry to repurchase a maximum of 50,069,116 ordinary shares, will expire at the companys next AGM, so the company will need to obtain a new shareholder resolution.

    Since on-market repurchases are relatively straightforward, typically companies do not require much input from their lawyers other than ensuring that the company has the relevant authority.

    A companys lawyers may also prepare the documents relating to the AGM, including the notice of the AGM, informing shareholders of the date and time of the meeting and setting out the resolutions that the company intends to put to shareholders.

    Off-market purchases

    Burberry entered into an agreement with GUS, which will allow the company to make off-market repurchases from GUS alongside the on-market repurchases.

    The off-market repurchases are necessary to ensure that GUSs shareholding in Burberry does not exceed the current level of 66.5 per cent. To facilitate this process, the two companies had to enter into a contract, requiring GUS to sell its shares in Burberry each time the latter company makes on-market repurchases.

    The contract had to be approved by Burberrys shareholders, so the company had to hold an extraordinary general meeting (EGM), at which a shareholder resolution approved the contract.

    The contract and various other documents, including Burberrys memorandum and articles of association, had to be displayed in the companys registered office to enable shareholders to review them before the EGM took place.

    Because off-market repurchases are more complicated than on-market purchases, Burberry and GUS received legal advice from Slaughter and May and Linklaters respectively on their arrangements.

    Recent examples of alternative methods of returning value to shareholders are:

  • B share issue. Last year both Stagecoach Group and Bristol Water chose to return value to their shareholders by carrying out bonus B share issues. B shares are special ordinary shares that enable a companys shareholders to either redeem the shares or to receive a special one-off dividend or have them converted to ordinary shares.

  • Reduction of capital. In 2002, high street retailer Next chose to return value to its shareholders through a combination of reducing the companys share capital and the creation of a new holding company. This route involved shares in the original company being cancelled and then the company issuing shares to a new top company. The top company (or holding company) then reduces its share capital in order to create distributable reserves, which can then be returned to shareholders.

    The process to reduce a companys share capital and the creation of a new holding company is relatively complicated and must be approved by the High Court and thus is made longer. The requirement for the company to obtain court approval is to protect the companys shareholders. This route also requires the company to prepare documents, which must be filed at the High Court.