|Summary: Tomorrow (Tuesday August 19) is the last day on which investors can buy shares in Telstra to be eligible to participate in the company’s $1 billion share buyback announced last week. The buyback presents as an opportunity for those in a 0% tax position, such as investors in pension mode, to potentially receive a higher payout on their shares than simply selling on-market.|
|Key take-out: If the tender goes through at the biggest possible discount to the market price, there is not a huge windfall for participants – however, for Telstra shareholders looking to reduce their exposure, it might be an attractive way to do this.|
|Key beneficiaries: General investors. Category: Shares.|
Telstra’s announced $1 billion off-market share buyback comes at an interesting time for investors – a nearly doubling of the Telstra share price over the past three years (from $2.95 in August 2011 to $5.50 now) might see some investors looking to unload a portion of their Telstra holdings and take some profits.
The buyback, which relies on investors on low tax rates being prepared to sell their shares at below market price in exchange for a healthy bundle of franking credits, might provide the vehicle for these investors to sell. Some investors on a lower tax rate might even look to take a position in Telstra tomorrow (Tuesday August 19), the last day that Telstra shares can be bought to participate in the buyback, as a more speculative opportunity to pick up some extra franking credits. All investors who hold Telstra shares at the close of trade tomorrow can participate in the buyback until the tender period closes on Friday, October 3.
The first thing we need to understand is the structure of the buyback.
The structure of the buyback
Telstra investors will be invited to tender (offer for sale) their shares to Telstra at a price that will be a 6% to 14% discount on the average price of Telstra shares for the five-day period up to October 3, 2014. Telstra shareholders nominate the discount that they are prepared to accept in this range. If the buyback discount is less than the 10% that they have nominated, they will participate in the buyback at the final buyback discount.
To put some numbers on this (and keep in mind that when shareholders tender the prices will be unknown, so they will just be choosing a discount to the final unknown price) – if we assume that the average Telstra price over that five-day period to October 3 is $5.50, then the actual price that Telstra shareholders will end up selling their shares back for will range from between $5.17 (6% discount) and $4.73 (14% discount).
The key element of the buyback is the way that this amount is paid to the shareholders.
The first $2.33 (per share) of this amount is a capital amount, and the remainder will be a fully franked dividend. My experience with previous buybacks of this nature is that they tend to be priced at the biggest discount. If this is the case, and based on the assumed prices discussed previously, this means the buyback price will be $4.73, with $2.33 being a capital payment and the remaining $2.40 (per share) as a fully franked dividend. A $2.40 fully franked dividend will see $1.03 of franking credits attached to the $2.40 cash payment.
We can already calculate the benefit of this to a 0% tax investor – either an individual with a low level of income or a superannuation fund paying a pension.
Again, assuming that the average Telstra price over the pricing period is $5.50 (which is something that is clearly an unknown at this stage), an investor who tenders their shares at the largest discount will receive:
- $2.33 as a capital payment;
- $2.40 as the cash payment for the fully franked dividend component of the dividend; and
- $1.03 as the value of franking credits.
The total value to a 0% tax investor (for example, a superannuation fund in pension mode) will be $5.76, even though the ‘official’ tender price is $4.73. This benefit is 5% higher than the assumed market price at the time of $5.50.
As soon as we model this same situation for a 15% superannuation fund investor, the outcome becomes significantly less efficient. The grossed-up dividend from the figures used above (cash payment and franking credits) of $3.43 attracts tax of 51 cents, which reduces the benefit to a superannuation fund not in pension mode to just $5.24. In this case an investor would probably be better off simply selling the shares on-market for $5.50 – depending a little on the capital gains tax that they might have to pay.
For a superannuation fund not in pension mode, it is not until the discount tendered to the market decreases to 10% that the benefit increases to $5.51, above the assumed market price of $5.50. Keep in mind that a superannuation fund not in pension mode still has to take into account capital gains tax. Selling for a capital amount of $2.33 might provide a capital loss that has some value for the fund.
For investors at higher tax rates it will almost certainly not make sense to sell into the buyback, as the tax payable on the fully franked dividend will wipe out the benefits of the franking credits.
The detail – The scale back
A twist in the buyback is the scaling process. All shareholders will have a ‘priority allocation’ bought back which, according to Telstra’s tender document, is expected to be 925 shares. There might be a query as to the fairness of this process – consider two self-managed super funds in pension mode, one with 900 shares and the other with 9000. The smaller fund will see all of their shares bought back and will benefit from the attractive fully franked dividend, whereas the larger fund will have the first 925 shares bought back and then the remainder of their holding scaled.
The tender documents also state that any investor who will be left with 375 shares or less after the buyback will have their tender accepted in full with no scale back, which effectively means that any investor with up to 1300 shares can expect to see their holding bought back in full.
There might be another group of investors who use this ‘priority allocation’. Tuesday this week (August 19) is the last day that Telstra shares can be purchased to participate in the buyback. Some investors on a 0% tax rate might see this as a speculative opportunity, and buy 1300 shares (925 priority allocation and 375 extra shares) in the hope that the benefit from the tender price is higher than the cost of buying the 1300 shares.
The final dividend
Telstra notes that even if shareholders participate in the buyback, they will receive the final dividend of 15 cents per share.
The structure of the Telstra buyback has been used by other companies previously, and is one of the ways that companies can use excess franking credits for capital management – in this case buying shares back at a price lower than the market price of the shares.
Theoretically it benefits all shareholders to some extent – because if there are fewer shares for a company, then earnings are divided amongst these fewer shares. The history of these buybacks suggests that they have tended to benefit those people on a 0% tax rate, especially self-managed superannuation funds in pension mode. If the tender goes through at the biggest possible discount to the market price, there is not a huge windfall for participants – however, for Telstra shareholders looking to reduce their exposure, it might be an attractive way to do this.
Scott Francis is a personal finance commentator, and previously worked as an independent financial adviser. The comments published are not financial product recommendations and may not represent the views of Eureka Report. To the extent that it contains general advice it has been prepared without taking into account your objectives, financial situation or needs. Before acting on it you should consider its appropriateness, having regard to your objectives, financial situation and needs.