Woodside's non-Shell shareholders have nothing to lose

If Woodside shareholders vote down the proposed $US2.7 billion buyback of Shell's residual shareholding, their directors may not be pleased. However, they shouldn’t be devastated.

A queue of institutional shareholders and proxy advisers have lined up in opposition to the proposed buyback of Shell’s remaining 9.5 per cent of Woodside, motivated by a mixture of principle, opportunism and self-interest.

The principle is that the buyback is a selective one, only available to Shell rather than to all shareholders. The opportunism and self-interest relate to the possibility that by blocking the Shell deal they might be able to force Woodside into an equal access buyback.

The buyback, to be put before shareholders on 1 August, is the second leg of a two-part transaction negotiated by Woodside and Shell and announced in mid-June.

The first leg was Shell’s sell-down to institutions of 9.5 per cent of Woodside to institutions for $3.2bn. The second was the buyback of the same number of shares by Woodside at a 14 per cent discount to market, conditional on shareholder approval, that would reduce the original 23 per cent Shell stake to about 4.5 per cent.

The two elements of the transaction were negotiated as a package, but were not interdependent. Thus, regardless of what happens at the shareholder meeting, Shell’s stake has already been reduced to 13.6 per cent.

It’s an interesting question whether Shell would have entered the transactions and split a shareholding with potential strategic value if it had believed there was a probability Woodside shareholders would reject the buyback.

From Woodside’s perspective, Shell’s shareholding and influence has been significantly reduced as has been the size of the over-hang in the market for Woodside shares. Shell, in the midst of a global asset sale and cost reduction program, would inevitably be forced to look to more conventional ways to offload its residual non-strategic shareholding if the buyback plan is rejected.

If that were the outcome it would be a major and quite costly setback for Shell and a temporary embarrassment for Woodside directors but not something that would have meaningful adverse implications for non-Shell shareholders.

The only real and significant argument of principle at stake at the meeting is the selective treatment of one shareholder relative to all others.

While there have been complaints about the $US1bn of franking credits that Shell would receive as part of the off-market buy-back (which is why it can be effected at a 14 per cent discount to market) Woodside would still have $US1.9bn of credits left and would continue to generate more credits from its future profits.

It could be argued, as Woodside does argue, that those are stranded or excess credits that have no value to the company or its shareholders. Therefore, deploying them in an off-market buyback of the bulk of Shell’s residual shareholding will generate enhanced earnings and dividends per share and therefore value for continuing shareholders.

The independent expert, Grant Samuel, calculated that the remaining franking credits would shelter a special dividend of up to $US4.4bn -- which Woodside isn’t going to declare any time soon -- which reinforces the view that the credits flowing to Shell have little if any real value to Woodside, although they clearly have substantial value to Shell.

The institutions opposed to the buyback are arguing for an equal access buyback for an obvious reason.

The value of the tax benefit (less the discount to market price) of an off-market buyback varies between shareholders depending on their tax rate but for non-taxpaying institutions, institutional and self-managed superannuation funds or taxpayers with a marginal rate below the top marginal rate they are very attractive. One institution has calculated that benefit as up to about $7 a share for non-tax-paying institutions and almost $4 a share for super funds.

There is, of course, no certainty that Woodside would conduct an equal access buyback if the Shell deal is voted down. It would, however, retain an under-leveraged balance sheet without obvious near-term opportunities to deploy its financial capacity within its business.

Woodside, apart from the prospective over-hang of Shell’s 13.6 per cent shareholding on the market for its shares, has argued that it would lose control over the nature and timing of any future exit by Shell, which could come at a time that was inconvenient for Woodside from a funding, market or project perspective, particularly if it coincided with an equity raising to fund future growth plans.

The sell-down would also enable Woodside to end the agreement under which Shell can appoint two directors to its board and remove the potential for conflict between a collision of Woodside’s expanding international ambitions and Shell’s own global operations and aspirations. That will happen over time anyway, given that Shell is a seller of its remaining shares.

If the buyback is voted down at the scheme meeting and the shareholder pressure for an equal access buyback were to prevail, Shell would, of course, be able to participate.

At best, however, (assuming, as is probable, that the buy-back would be rushed by institutional shareholders) the number of shares it owned would be trimmed at the margin if it did participate, while its proportionate share of Woodside’s capital would be unchanged.

It would be unusual for the blue-chip board of a blue-chip company to be rolled by shareholders on a proposal that the directors have committed to and support strongly.

But, with Shell unable to vote at the meeting, a 75 per cent threshold for approval and nothing to lose for the non-Shell shareholders, it is looking increasingly likely that will be the outcome.