A company at 25x earnings issues bonds at 8% to buy back its own shares. What happens to EPS, and what happens to leverage and the rating as bondholders see it?

EPS falls about 5.6%, from Rs 4.00 to Rs 3.78, because the retired shares earn 4% of their price and the debt costs 6% after tax. The buyback would add to EPS only below a P/E of about 16.7. For bondholders the deal is plainly negative: debt goes from zero to 1.67x EBITDA with no new earnings behind it, and the cash has left the company. The rating likely holds at this level, but the policy is the risk.

Compare what the retired shares earn with what the money costs. A debt-funded buyback raises EPS only when the earnings yieldEarnings per share divided by the share price, the inverse of the P/E. A P/E of 25 is an earnings yield of 4%. of the shares bought is above the after-tax cost of the debt. At 25 times earnings each share earns 4% of its price. The debt costs 8% times one minus 25%, which is 6%. A household that borrows at 6% to pay off a loan charging it 4% is worse off every month.

Rs 1,000 crore at Rs 100 a share buys 10 crore shares, leaving 90 crore. Interest is Rs 80 crore, Rs 60 crore after tax, so net income falls to Rs 340 crore. EPS is 340 over 90, Rs 3.778, down 5.56%. The same buyback at 12 times earnings would buy back 20.8 crore shares and lift EPS by 7.4%: the answer turns on the share price, not on the act of buying back.

From the other side of the balance sheet. The company borrows Rs 1,000 crore and gives it all away to shareholders: no plant, no customers, no earnings arrive with the debt. Leverage goes from zero to 1.67x EBITDA and EBIT covers interest 6.7 times; if EBITDA fell 30% in a downturn, leverage would be 2.38x. Those are comfortable numbers for most ratings, so the rating need not fall. What an analyst weighs more is the signal: a board willing to borrow for buybacks when EPS falls may do it again, and a financial policy that moves leverage from zero to nearly two turns in one step is a policy agencies mark down.

Close with a view. At 25 times earnings, this buyback hurts EPS and weakens the credit at the same time, so it fails on both counts. If the board's aim is to return cash, a smaller buyback from free cash flow, or a dividend, would do it without adding debt. The limitation of the EPS test is that it ignores value: if the shares were genuinely cheap, a buyback could create value even while EPS fell.