When a company wants shareholders to turn in a portion of their shares for a cash payment, it has two options: it can redeem or repurchase the shares.
Share repurchases are when a company that issued the shares repurchases the shares back from its shareholders. During a repurchase or buyback, the company pays shareholders the market value per share. With a repurchase, the company can purchase the stock on the open market or from its shareholders directly. Share buybacks are a popular method for returning cash to shareholders.
Redemption is when a company requires shareholders to sell a portion of their shares back to the company. For a company to redeem shares, it must have stipulated up front that those shares are redeemable, or callable. Redeemable shares have a set call price, which is the price per share that the company agrees to pay the shareholder upon redemption. The call price is set the onset of the share issuance.
Redemption or Repurchase
A company may choose repurchase over redemption for several reasons. When the stock is trading below the call price of redeemable shares, the company can obtain the shares for a lower cost per share by buying them from shareholders through a stock buyback. The company might offer, as an incentive, to repurchase the shares at a higher price than the current market, but below the call price of the redeemable shares.
A company might repurchase shares with the goal of reducing outstanding shares, which increases earnings per share or EPS. As a result, a repurchase typically drives a stock price higher by reducing the supply of outstanding shares. When the stock price is low, the company might also adopt a buy-low, sell-high strategy and earn a profit on the resale of the shares at a later date.
Sometimes the company buys back enough of its shares to regain majority shareholder status, which is obtained by owning more than 50% of the outstanding shares. A majority shareholder can dominate voting and exercise heavy influence over the direction of the company.
A company has issued redeemable preferred stock with a call price of $150 per share and has chosen to redeem a portion of them. However, the stock is trading at $120 in the market. The company's executives might choose to repurchase the shares rather than pay the $30-per-share premium associated with the redemption. If the company is unable to find willing sellers, it can always use the redemption as a fallback.
Conversely, if a company currently pays a 3% dividend rate on shares outstanding but has redeemable shares outstanding that carry a higher dividend rate, the company might elect to redeem the more expensive shares, with the higher dividend rate. One advantage to issuing redeemable shares is that it gives a company flexibility if they choose to buy back shares at a later date.
Companies can sometimes buy and sell stock like investors. If a company's executive management believe their stock is undervalued, they may choose to buy back shares at the perceived-discounted price. If the stock price appreciates in the future, the company has the option of issuing shares at the higher price per share, earning a gain from the sale when compared to the original repurchase price.
The Bottom Line
A repurchase involves a company buying back shares, either on the open market or directly from shareholders. Unlike redemption, which is compulsory, selling shares back to the company with a repurchase is voluntary. However, a redemption typically pays investors a premium built into the call price, partly compensating them for the risk of having their shares redeemed.