AIX: A special opportunity for SMSFs

The background

If you haven’t yet read Intelligent Investor Share Advisor’s article on the wind up of Australian Infrastructure Fund, called capital gains tax treatment won’t be available. This is more penal for individuals than SMSFs.

An individual investor may start off with a 12% return, but this very quickly becomes 5% or less if the cash gets delayed or doesn’t come in as forecast. An SMSF’s low (or zero) tax rate offer a far better starting return, and more margin for error if things slip.

We’ve prepared a basic excel calculator to allow you to assess the impact on returns of distributions missing the forecasts, both in their amount and timing.

Don’t forget there’s also the possibility AIX have been too conservative in their estimates. There might be some upside beyond the optimistic numbers in the Explanatory Booklet.

Risks

Nathan’s article explained why this is not an arbitrage transaction. Commercial risks on both the sale and distribution remain. What could go wrong?

1. Delay in pre-emptive rights and consent process. Under some of its shareholder agreements, AIX has to offer its co-investors the right to buy the assets before selling them to Future Fund. In some cases, it needs the Future Fund to be approved as a new investor. If one or more of the co-investors exercises their ‘pre-emptive rights’ AIX will still receive the same proceeds (minus the fee payable to Future Fund) and it’s unlikely Future Fund wouldn’t be approved as an investor, so neither of these are major concerns.
   
   The risk is a dispute or process delay that impacts the timing of distributions or causes AIX to incur unexpected costs. Reports in the Australian Financial Review suggest some co-investors are unhappy with the way the Future Fund has valued AIX assets subject to pre-emptive rights. If legal action was to ensue, it could lead to delays in completing the sale and distributing proceeds.
    
2. Unexpected liabilities. The sale to AIX requires the parties to make adjustments if unexpected liabilities (either actual or contingent) arise. We doubt AIX under-baked its liabilities in negotiating the sale agreement with the Future Fund, so this isn’t a major risk, although it doesn’t negate the possibility entirely. Transaction costs (or other expenses) may also be higher than anticipated, reducing distributions.
    
3. Delay of Residual Return. The Residual Return requires further approvals from securityholders and needs franking credits available. There’s a risk that this may be delayed to as late as December 2013 (or possibly longer). A delay in the payment of the Residual Return is therefore a significant risk, although it doesn’t impact the returns greatly.

This isn’t to scare you off this opportunity but it is a gentle reminder that things can go wrong. Importantly for pension mode SMSFs, even if the Main Return is delayed until June, the Residual Return until December and the forecasts come in lower than anticipated, the return would still be over 10% per annum.

Purchase price

One final point on ‘purchase price’: This is a short-term opportunity leveraged to the purchase price. A purchase price of $3.10 delivers a 0% SMSF a 22% return and a generous margin for error. At $3.15 and above, you’d need to be very confident about the timing and amount of the distributions. So please, don’t chase the price up.

The proposed deal is not attractive to everyone. Non-resident shareholders in particular will suffer withholding tax of 15%-30% on a portion of their distributions (see pages 15 and 45 of the Explanatory Booklet). So whilst 0% SMSFs may be keen to buy, others may create offsetting selling pressure.

Final comments

This seems like a ‘get in with your ears pinned back’ opportunity but it is important to remember portfolio limits and diversification. We suggest no more than 10% of your portfolio be allocated to this situation. Things can and do go wrong from time to time and this limit will minimize your exposure to that possibility.

Note: Original article (and spreadsheet) amended post-publishing due to query over franking credits. We spoke to the manager and confirmed the table on page 7 does not include 2 cents of franking credits which are expected to be distributed as part of the cancellation of AIFT units in April (but have no net franked dividend income associated with them). Therefore total franked dividend income is expected to be 8 cents per unit and total franking credits 5 cents (3 cents attached to the dividend and another 2 cents distributed from AIFT).