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Understanding the Stock Buyback

Maybe you have read this news on the media: PT Abcd had  a buyback plan on its shares in the market. What is buyback? I’m sure you have already known: Buyback is re-purchase of the issued and outstanding shares in the market, by the company itself. But what does it means? And what’s its influence towards the shares price of the related company?

Basically, buyback is done to keep the nominal value of total issued and paid up capital, if the majority of the capital in are not liquid in the market within a specified period. For example, PT Abcd issued 10 billion of shares where 3 billion of it was distributed to the market through IPO. If it turns out that from 3 billion piece of stocks, only 2 billion that has absorbed by the public investors and actively traded, while the remaining 1 billion stays idle, aka not purchased or owned by anyone after a certain time, then in this case, the company should perform buyback. If not then the nominal value of paid-up capital can be corrected where the 1 billion pieces of idle shares will be crossed out by the stock exchange authorities and considered never been published.

As time goes, the companies’ owner started to see the other function of buyback, which is become one of the methods to increase the stock price, or at least to keep it from declining. Alternatively, it can also become a method to raise the liquidity. So, we can call buyback as: One of the techniques to manipulate the stock price in the market. For example is the global crisis on 2008. At that time, the government spent Rp4 trillion tp bought up the state-owned enterprises’ shares at very low prices. For both big fish or retail investors, it sounded like: ‘Relax! If there’s something happen or the shares fell down, then we (the government) will be responsible!’. It was similar with the bail out. This way is expected to restore the investors’ trust, and surely will increase the share price. So there is a psychological factor in here.

So, the companies can also do the same by buyback its company’s shares. Usually, this method will be taken if the owner cannot find strategic investor to buy its company’s shares in large quantity. The point is, if there is someone buy certain share in large amount, either the majority owner himself or other big investor, then the retail trader in the market will believe that the share is indeed good, and will increase. If not, why would anyone want to bought it up? So once again, this is a psychological play.

Buyback will cause the outstanding shares to decline. For example the outstanding shares of a company was 10 million shares, and the shares that can be owned by the public was 3 million shares. If the company did buyback 1 million of shares, then the shares that can be held by the public are only 2 million. Fewer amount means a reduce in offer. If judging from the law of economic: when the offer decreases but the demand remains the same, the price of goods (stocks) will automatically go up.

Interestingly, the mechanism of supply and demand in the capital market in Indonesia (and maybe in other countries too) is usually like this: When a stock price has gone up, it is only then that investors’ demand for the stock will rise. It means that when the stock price is high, the company may sell shares from buyback at a high price and will most likely run out by the market, because the demand is great. In this way, the company can reap the benefits that are not small. So if there is a question, when does the company normally sells back shares from buyback? Then the answer is when the time is right, that's all.

The buyback process cannot be done carelessly, means that a company cannot arbitrarily buy and sell back their shares anytime. There are also some provisions for the maximum number of shares to buyback. You can read that on Bapepam’s website.

One of the entrepreneurs who are frequently did buyback is Mr. Hary Tanoe, towards Media Citra Nusantara (MNCN). Most recently, Mr. Harry did buyback of  2 million shares of MNCN on June 21 and announced it on last  29 June. And consequently, although it did not rose, but MNCN remained in position of 330, after in the previous 5 days continued to drop drastically from position of 435. Previously, MNCN also been announced that they have done a buyback on June 2 and June 21, 2010. The result? On 3 June, MNCN rose from 375 to 385, and on June 22, MNCN rose from 420 to 425.

So whether the shares of certain company will surely go up if the company does buyback? Not necessarily. Buyback indeed is one of the methods to rise the shares price or keep it from further decline, but surely not all method will work, right? So in the end, you still need to check on the fundamental and technical analysis of the related shares, before deciding to go in.

Bonus: Technically, there is a chance for MNCN to strengthened in the near future, probably into the position of 360 (when this article was written, MNCN was on the position of 330). To become more stable, try to enter in the position of 320 or 325.

Original article was written on July 1st, 2010.

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